Question

A gold-mining firm is concerned about short-term volatility in its revenues. Gold currently sells for $2,050 an ounce, but the price is extremely volatile and could fall as low as $1,950 or rise as high as $2,150 in the next month. The company will bring 1,350 ounces of gold to the market next month.

a. What will be the total revenues if the firm remains unhedged for gold prices of (i) $1,950, (ii) $2,050, and (iii) $2,150 an ounce?

b. The futures price of gold for delivery 1 month ahead is $2,070. What will be the firm’s total revenues if the firm enters into a 1-month futures contract to deliver 1,350 ounces of gold?

c. What will be the total revenues if the firm buys a 1-month put option to sell gold for $1,350 an ounce? The put option costs $47 per ounce.

Answer 1

a)		Calculation of revenue (Firm remain unhedged)
		Gold (in ounce)	Price	Total revenue(Gold * price)
	1)	1350	$1,950	$2,632,500
	2)	1350	$2,050	$2,767,500
	3)	1350	$2,150	$2,902,500
b)		Total revenue if the firm enters future contract for 1 month at $ 2070 per ounce
			=	Future price per ounce*gold ounce
			=	$2070*1350
			=	$2,794,500
c)		If the firm buys put option to sell gold at $1350 an ounce after one month,The net revenue to firm would be Exercise price reduced by premium paid.
		Net revenue per ounce		=	$1350-$47=1303 per ounce
		Total revenue		=	$1303*1350 ounce
				=	$1,759,050
	*	A put option gives you right to sell at the exercise price.
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