Suppose that price and quantity are positively correlated as in this table: There is a 50% chance

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Suppose that price and quantity are positively correlated as in this table:
There is a 50% chance of either price. The futures price is $2.50. Demonstrate the effect of hedging if we do the following:
a. Short the expected quantity.
b. Short the minimum quantity.
c. Short the maximum quantity.
d. What is the hedge position that eliminates variability in revenue? Why?
€¢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
Suppose that price and quantity are positively correlated as in

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

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Derivatives Markets

ISBN: 9789332536746

3rd Edition

Authors: Robert McDonald

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