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Describe how to use futures contracts to hedge. Calculate the profit or loss of using futures...

Describe how to use futures contracts to hedge. Calculate the profit or loss of using futures contract.

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Answer #1

When a company knows that it will be making a purchase in the future for a particular item/commodity, it should take a long position in a futures contract to hedge its position. For example, suppose that Company A knows that in 1 year, it will have to buy 1kg of silver to fulfill an order. So to hedge its position against variation in price of silver, it should buy futures for silver so that Company can buy 1 kg of 1 year from now at a predecided price.

Now let's say current silver price is $200/kg. And company decided to buy a silver future (1 year maturity) at $210. Now, in year, if silver price is $220/kg, then you will be having a profit of $10 ($220 - $210). In other case, if the silver price is $200 in 1 year, then the loss of the company will be $10 ($200 - $210).

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