The profit margin of WeDig: 23.63% the copper price at which WeDig achieves exactly its target rate:
Question:
The profit margin of WeDig: 23.63%
the copper price at which WeDig achieves exactly its target rate: 9146.34
the critical copper price for WeDig: 8620.69
the forward price for a contract expiring on 1 Nov 2022: 9893.93
1. WeDig considers the following five hedging strategies for managing commodity price risk:
Strategy I: No hedge at all.
Strategy II: Hedging 100% of the mining output with a forward contract.
Strategy III: Hedging 40% of the mining output with a forward contract and leaving the remaining 60% unhedged.
Strategy IV: A strategy using one of the options given above to meet the target rate and benefit from favourable movements in the copper price.
Strategy V: A strategy using one of the options given above for worst-case protection only (meet critical rate).
For each of these strategies:
Calculate the profit margin for the following two scenarios:
a) The copper spot price on 1 Nov 2022 is $10,500 per ton.
b) The copper spot price on 1 Nov 2022 is $8,300 per ton.
2. Explain the advantages and disadvantages of each hedging strategy.
3. If a strategy includes options, state clearly which option contract should be used, whether as a long or short position, and why.
4. As an alternative hedging strategy, WeDig is also considering using copper futures contracts traded on the London Metal Exchange, which is a world leading derivatives marketplace for industrial metals. Without any calculations, discuss advantages and disadvantages of a hedging strategy using LME futures as compared to using forward contracts with the WeTradeDerivatives bank.
Accounting What the Numbers Mean
ISBN: 978-0078025297
10th edition
Authors: David H. Marshall, Wayne W. McManus, Daniel F. Viele