Question

Goldmember Corp. anticipates a future purchase of 100,000 oz. of gold in one month for its gold plating business. Today is January 28. Today’s spot price for gold: S0 = $1,000 per oz. One month, continuously compounded risk-free rate: r = 2% (annualized) Storage costs for gold for one month, payable up front: C = $1.00 per oz. Futures price for March gold futures: F0 = $990 per oz. Which strategy is better for the company?

Group of answer choices:

Take out a loan today to buy gold at today’s spot price, store the gold for one month, and pay storage fees.

Hedging by taking a long position in March gold futures.

Answer 1

To purchase one oz. of gold, Goldmember Corp. has to take a loan of $1000 + $1 (for storage) =$1001 for one month

After one month , amount payable = 1001*exp(0.02*1/12) = $1002.67

So, the net purchase price per oz. of gold will be $1002.67

However, if the gold futures are purchased today, an effective price of $990 per oz. of gold after one month can be locked in by Goldmember corp.

As the cost of gold is lower in the Hedging alternative, Hedging by taking a long position in March gold futures is a better strategy.