Consider the case of Tolbotics Copper Inc., 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 1,250,000 pounds of copper in this six months. (Note: Copper futures are traded at a standard size of 250,000 pounds.)

If the company does hedge the copper it produces, it can expect to earn a total revenue (xxxx) of at the end of six months.

If Tolbotics places a hedge on its copper production in the futures market, it would sell (xxxx) 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. Calculate the expected revenue in the following markets:

Futures Market Net gain or loss in the futures market: $1,875,000 -$700,000 $4,987,500 -$5,862,500

Cash Market Revenue received in the cash market: $475,000 $4,987,500 $3,987,500 $875,000

The cost of production of copper is $4,687,500. Although copper prices have decreased, Tolbotics has still made a profit of $1,175,000 because of the gain on its copper futures contracts. This hedging strategy would be referred to as a (LONG or SHORT) hedge, and it helps protect the producer to sell a commodity against falling prices.

Answer rating: 100% (QA)

If Tolbotics hedges its copper production in the futures market by selling copper futures contracts ... View the full answer