# Question: Consider the example of Auric a Suppose that Auric insures against

Consider the example of Auric.

a. Suppose that Auric insures against a price increase by purchasing a 440-strike call. Verify by drawing a profit diagram that simultaneously selling a 400 strike put will generate a collar. What is the cost of this collar to Auric?

b. Find the strike prices for a zero-cost collar (buy high-strike call, sell low-strike put) for which the strikes differ by $30.

•XYZ mines copper, with fixed costs of $0.50/lb and variable cost of $0.40/lb.

•Wirco produces wire. It buys copper and manufactures wire. One pound of copper can be used to produce one unit of wire, which sells for the price of copper plus $5. Fixed cost per unit is $3 and noncopper variable cost is $1.50.

•Telco installs telecommunications equipment and uses copper wire fromWirco as an input. For planning purposes, Telco assigns a fixed revenue of $6.20 for each unit of wire it uses.

The 1-year forward price of copper is $1/lb. The 1-year continuously compounded interest rate is 6%. One-year option prices for copper are shown in the table below.17

In your answers, at a minimum consider copper prices in 1 year of $0.80, $0.90, $1.00, $1.10, and $1.20.

a. Suppose that Auric insures against a price increase by purchasing a 440-strike call. Verify by drawing a profit diagram that simultaneously selling a 400 strike put will generate a collar. What is the cost of this collar to Auric?

b. Find the strike prices for a zero-cost collar (buy high-strike call, sell low-strike put) for which the strikes differ by $30.

•XYZ mines copper, with fixed costs of $0.50/lb and variable cost of $0.40/lb.

•Wirco produces wire. It buys copper and manufactures wire. One pound of copper can be used to produce one unit of wire, which sells for the price of copper plus $5. Fixed cost per unit is $3 and noncopper variable cost is $1.50.

•Telco installs telecommunications equipment and uses copper wire fromWirco as an input. For planning purposes, Telco assigns a fixed revenue of $6.20 for each unit of wire it uses.

The 1-year forward price of copper is $1/lb. The 1-year continuously compounded interest rate is 6%. One-year option prices for copper are shown in the table below.17

In your answers, at a minimum consider copper prices in 1 year of $0.80, $0.90, $1.00, $1.10, and $1.20.

## Answer to relevant Questions

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