Question

A company will buy 1000 units of a certain commodity in one year. It decides to hedge its risk exposure using futures contracts. The current  futures price for one-year contract delivery is $90. If the spot price and the futures price in one year on the maturity date turn out to be $112 and $110, respectively, what is the net price paid for the commodity using reverse trade to settle futures (i.e., settle futures via reverse trade and buy commodity in spot market)?

		$92
		$96
		$102
		$106

Answer 1

Solution:-

Cost of 1000 units at 1 year spot price = 1,000 * $112 = $1,12,000

Hedge 1,000 units at current Future Price = 1,000 * $90 = $90,000

Hedge 1,000 units in 1 year at future price = 1,000 * $110 = $1,10,000

Hedge Payout at one year = $1,10,000 - $90,000

Hedge Payout at one year = $20,000

Cost of 1,000 unit in year due to hedging = $1,12,000 - $20,000 = $92,000

Net Price Paid for commodity =

Net Price Paid for commodity = $92.

Hence, The correct answer is point A i.e. $92.

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