A gold-mining firm is concerned about short-term volatility in its revenues. Gold currently sells for $300 an
Question:
A gold-mining firm is concerned about short-term volatility in its revenues. Gold currently sells for $300 an ounce, but the price is extremely volatile and could fall as low as $280 or rise as high as $320 in the next month. The company will bring 1,000 ounces to the market next month.
i. What will be total revenues if the firm remains unhedged for gold prices of $280, $300, and $320 an ounce?
ii. The future price of gold for delivery one month ahead is $301. What will be the firm's total revenues at each gold price if the firm enters into a one-month futures contract to deliver 1,000 ounces of gold? Does the firm buy or sell futures contract?
iii. What will total revenues be if the firm buys a one-month put option to sell gold for $300 an ounce? The put option costs $2 per ounce.
iv. What are the advantages and disadvantages of using futures rather than options to reduce risk?