8. Hedging strategy to protect against falling prices Aa Aa 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 Purple Panda Industries, a large copper-producing company: The company's cost of producing copper is about $3.30 per pound. The current market price for copper is $3.96 per pound. The six-month futures price for copper is $4.13 per pound. At this selling price, the company can maintain its earnings growth. The company expects to produce 500,000 pounds of copper in this six months. (Note: Copper futures are traded at a standard size of 250,000 pounds.) If Purple Panda places a hedge on its copper production in the futures market, it would contracts for delivery in six months at a delivery price of $4.13 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 $2.81 per pound in the cash markets. Calculate the following: Net Cash Flow from sale of Copper Gain or Loss |(including gain or loss on futures) on Futures $660,000 $1,755,000 O $1,405,000 $1,755,000 -$2,065,000 $245,000 $2,065,000 $660,000 Thus, Purple Panda will in the futures market. This hedging strategy would be referred to as a hedge, and it helps protect the producer to sell a commodity against falling prices