6. Hedging strategy to protect against falling prices A Aa E Price fluctuations in commodities can have significant consequences for companies, especially if the fluctuation involves a prime raw material for a company. Different companies will adopt different strategies to manage the risk in price fluctuations, including adjusting the timing of their commodity purchases, maintaining a safety stock of their raw materials, and hedging. Consider the case of Cranked Coffee Company, a large copper-producing company: The company's cost of producing copper is about $3.75 per pound. The current market price for copper is $4.50 per pound. The six-month futures price for copper is $4.69 per pound. At this selling price, the company can maintain its earnings growth. The company expects to produce 750,000 pounds of copper in this six months. (Note: Copper futures are traded at a standard size of 250,000 pounds.) at the If the company does not hedge the copper it produces, it can expect to earn a total revenue of end of six months. If Cranked Coffee places a hedge on its copper production in the futures market, it would contracts for delivery in six months at a delivery price of $4.69 per pound to generate profits that maintain its desired earnings growth. When the contract comes due in six months, the spot price of copper is $3.19 per pound in the cash markets. Prices on the new six-month futures contracts in copper are $3.99 per pound. Calculate the expected revenue in the following markets: Cash Market Net gain or loss in the cash market: O -$2,992,500 $285,000 O -$420,000 O $525,000 Futures Market Net gain or loss in the futures market: O-$420,000 O $2,992,500 O $1,125,000 O -$3,517,500 at the if the company does not hedge the copper it produces, it can expect to earn a total revenue of end of six months. If Cranked Coffee places a hedge on its copper production in the futures market, it would contracts for delivery in six months at a delivery price of $4.69 per pound to generate profits that maintain its desired earnings growth. When the contract comes due in six months, the spot price of copper is $3.19 per pound in the cash markets. Prices on the new six-month futures contracts in copper are $3.99 per pound. Calculate the expected revenue in the following markets: Futures Market Cash Market Net gain or loss in the cash market: -$2,992,500 $285,000 -$420,000 $525,000 Net gain or loss in the futures market: O -$420,000 $2,992,500 O $1,125,000 O -$3,517,500 in the futures market and The cost of production of copper is $2,812,500. Thus, Cranked Coffee will in the cash market This gain and loss offset each other, and the company benefits from placing the hedge. This hedging strategy would be referred to as a hedge, and it helps protect the producer to sell a commodity against falling prices MacBook Air