Assignment: Basis risk in Silver long hedge Suppose that you are a silver fabricator. You will acquire 2,000,000 troy ounces of silver at the prevailing market price on May 2 from your long-time business partner. But, you worry about the uncertainty in the market price of silver in the future. Hence, you decided to use Globex ("online") silver futures contracts to hedge risk. You will place an order of silver futures contracts at the last day closing price of the date when you enter into the futures contracts. (1) Which month maturity do you have to use? (2) State the date you enter into the silver futures contract and futures price (last closing price) that you determined. *Use the same date and closing price that you use for the assignment of "perfect" long hedge. Last closing price $23.6958=23.70 (3) Assume that the spot and futures prices in May 2 are $11 and $10.5 per ounce, respectively. (3a) Find out the effective buy price and compare with the locked-in future price. Are they the same? Find out the value of basis. (3b) Find out profits of the unhedged spot position, futures position and hedged position. (Hedge position = unhedged spot position + futures position) (4) Assume that the spot and futures prices in May 2 are $35 and $34 per ounce, respectively. (4a) Find out the effective buy price and compare with the locked-in future price. Are they the same? Find out the value of basis. (4b) Find out profits of the unhedged spot position, futures position and hedged position. (Hedge position = unhedged spot position + futures position) (5) Discuss the effectiveness of your hedge. Is the hedge perfect or imperfect? Does the purchase cost of silver depend on the uncertainty in the market price?