Question
In: Finance
Suppose that a manufacturer has an ongoing need for silver as a raw material in the...
Suppose that a manufacturer has an ongoing need for silver as a raw material in the production process, and is concerned about the risk of the price of silver going up. The firm is considering two hedging choices: futures contracts and option contracts. Suppose that the firm decides to hedge using futures contracts. Should it buy or sell futures contracts? Explain.
Solutions
Expert Solution
The firm should buy Future contracts in order to hedge the risk of rising price of silver.
Reason-
A futures contract is a contract between two parties where both parties agree to buy and sell a particular asset of specific quantity and at a predetermined price, at a specified date in future
The manufacturer uses silver as raw material in production process.It is afraid of silver prices rising.On buying a Future contract on silver,the firm locks up a price today at which silver can be purchased by the firm at a future date (maturity date of future contract).Hence even if there is rise in silver price at a future date, the firm can buy silver at lower contracted rate (rate at which future contract is purchased today) at future date (when the actual silver rate is high)
Therefore the firm should buy future contract for hedging silver price hike risk.
If you hve any doubt,please ask in the comments
jeff jeffy answered 5 months agoRelated Solutions
Suppose that a manufacturer has an ongoing need for silver as a raw material in the...
Suppose that a manufacturer has an ongoing need for silver as a
raw material in the production process, and is concerned about the
risk of the price of silver going up. The firm is considering two
hedging choices: futures contracts and option contracts.
(i) Suppose that the firm decides to hedge using futures
contracts. Should it buy or sell futures contracts? Explain.
(ii) Suppose that the firm decides to hedge using option
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PLANT
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Philadelphia
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Sycamore Plastics (SP) is a manufacturer of polyethylene plastic pellets used as a raw material by...
Sycamore Plastics (SP) is a manufacturer of polyethylene plastic
pellets used as a raw material by manufacturers of plastic goods
around the U.S. SP currently operates four manufacturing centers in
Philadelphia, PA; Atlanta, GA; St. Louis, MO; and Salt Lake City,
UT. The plants have different capacities and production costs as
indicated in the table below.
PLANT
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(× 100,000 LBS.)
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COST
(PER 1,000 LBS.)
Philadelphia
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Atlanta
9.5
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St. Louis
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Sycamore Plastics (SP) is a manufacturer of polyethylene plastic
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around the U.S. SP currently operates four manufacturing centers in
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plant 2
plant 3
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500
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98,000
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1,125,000
217,000
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88,000
78,000
Ending inventory, work in process
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138,000
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