Question

1. A company will buy 1000 units of a certain commodity in one year. It decides to hedge 90% of its exposure using futures contracts. The spot price and the futures price are currently $100 and $90, respectively. The spot price and the futures price in one year turn out to be $112 and $110, respectively. What is the average price paid for the commodity?

Answer 1

This should not be too hard now. We're given that the company will buy 1,000 units of a commodity, for which it will buy futures of upto 90% of the demand and the futures are currently trading for $90, which just means the company can get 900 units of this commodity at $90 per unit in 1 year's time. Note that 10% or 100 units will then have to be bought at market prices.

So after 1 year lapses, the price in the market is $112. The company will buy 900 units at $90 per unit, which totals to $81,000. The remaining 100 units will have to be bought at $112, totalling to $11,200. The total price they paid this way comes to $92,200 for 1,000 units, or an average of $92.20 per unit.

Hope that helps! :)

answered by: anonymous