A copper mining company is intending to sell 2000 tonne of copper on March 8th, 2017, but is concerned about the increased volatility in the copper spot price. Today September 7th, 2016, the copper spot price is $2090/tonne and the June 2017 Futures price is $2220/tonne. On March 8th, 2017, the copper spot price outturn is $2640/tonne and the June 2017 Futures price is $2680/tonne.
1) Determine the gain (loss) on the sale of copper if the company had not hedged the delivery.
2) Determine the gain (loss) on the sale of copper if the company had hedged the delivery.
3) By comparing your answers to parts (1) and (2), explain whether or not the hedge compensates for the movement in the spot price between September 7th, 2016 and March 8th, 2017.
4) Discuss the relative advantages and disadvantages of whether hedging against price variations should be done using a forward or futures contract.
.1) If the company had not hedged the delivery:
Spot price =$2090 per tonne
Total sales revenue at spot price=2000*$2090=$4,180,000
Spot price on March 8=$2640/tonne
Sales Revenue without hedging =2000*$2640=$5,280,000
Gain =$5,280,000-$4,180,000=$1,100,000
.2) If the company had hedged the delivery:
June 17 Future price today=$2220 per tonne
June 17 Future on March 8 , 2017=$2680 per tonne
Loss in futures=(2680-2220)*2000=$920,000
Net Gain =($1,100,000-$920,000)= $180,000
3) Hedge did not compensate fully movement of spot price
4) In case of hedge with futures, the price is not locked. If prices go up ,there is loss in futures.
Hedge with futures is beneficial if prices come down.
Hedging with forward, the price is locked. Only the contract is executed on a future date. Hence there is no risk
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