Question

Please read the list of the potential risks the companies are facing.

A) A big copper producer is willing to hedge its price risk on 50 tons of copper it expects to produce by November 2019.

B) A large telecommunications company is willing to hedge its interest rate risk on the Libor+3.5% semi-annual interest payment $500 million 4-year syndicated loan, which matures in Feb 2023.

C) A machine manufacturer is willing to hedge its price risk on 75 tons of aluminium required for its production process in the first half of 2020.

Requirements:

1. Choose one case from the above list.

2. You are required to devise a hedging strategy for the chosen companies. The hedging strategy must include a recommendation of at least 2 different alternatives (using options, forwards, futures or swaps, etc). The following details for each strategy must be discussed:

• contract specifications (pay attention to the dates/months of the contracts, and attach links to the specific contracts, which you recommend using. Use the derivatives exchanges discussed in class for quotes/prices of the specific contracts)
• calculation of a number of contracts required for each strategy,
• estimates of the costs of the strategies suggested,
• pros and cons of each strategy

3. Out of the two hedging alternatives suggested by you, choose the best one in your opinion and justify your choise.

I recommend that you present the case from the standpoint of a derivatives sales representative of an investment bank. You are willing to sell one of the hedging alternatives to the client (me) and make a big bonus on this transaction.

Your presentation must be concise, structured, clear and nice looking in order for you to get the bonus. The format of the presentation is not important, do it whichever way is convenient.

Answer 1

here first option i.e. option to hedge copper with future contract:

suppose if we consider this months price of copper is 3200$/ton and if we hedge it with 6 month forward contract which is

3400$/ton.

as per the contract they need to sell its copper by 3200$/ton resulting net sales 1,60,000$

but if we hedge it with 6 months future we are getting premium of 200$ per ton so 10,000$ surplus.

suppose if we consider price fall after 6 months to 3000$ than also we can buy that future at that time and we will get 400$ by hedging than also we will be in profit

in case of increase in price from 3200$ to 3600$ ,we will have loss of 200$ in future but we are having copper in physical form so we can sell it on higher price than also we will get the same amount so there would no loss also in that case.

2nd strategy is of option strategy:

where we should write off calls and puts of 6 months of copper.

for example:

right now the price of copper is 3200$/ton and price of call 3600$/ton is 100$ for next month so if you anticipate the range of copper is 10% in a month than you will get full 100$ by selling it and one can hedge in options also by buying 3300$ call by selling 3400$ call so risk would be limited.