Question

The management of a jewelry store plans to buy gold in the future and seeks protection against an increase in the price of gold. The current price of gold is $352.40 per ounce. The futures price of gold is $397.80 per ounce. The number of ounces to be hedged is 1,000, and the number of ounces per futures contract is 100. Therefore, 10 contracts will be hedged.

Describe in detail the hedge created by the jewelry store. That is what actions would be taken and why? We understand this would protect us against an increase in gold. What else can be said about the hedge?

Answer 1

The jewellery store shall enter into a contract to buy gold in future at the rate of $397.80 per ounce. They have to but a totla of 1000 ounces for $397,800. Entering into future contract will make their effective buying price as $397.80 per ounce.

If the spot price at expiration of the contract is any more than $397.80 per ounce, then there will be a benefit of entering into a contract. however if the expectations do not materialize, then there shall be a loss and they have to buy at a higher rate as per contract.