Concept explainers
Futures and options A gold-mining firm is concerned about short-term volatility in its revenues. Gold currently sells for $1,300 an ounce, but the price is extremely volatile and could fall as low as $1,220 or rise as high as $1,380 in the next month. The company will bring 1,000 ounces to the market next month.
- a. What will be total revenues if the firm remains unhedged for gold prices of $ 1,220, $1,300, and $1,380 an ounce?
- b. The futures price of gold for delivery one month ahead is $1,310. What will be the firm’s total revenues at each gold price if the firm enters into a one-month futures contract to deliver 1,000 ounces of gold?
- c. What will total revenues be if the firm buys a one-month put option to sell gold for $1,300 an ounce? The put option costs $110 per ounce.
a)
To determine: Total revenue when firm remains unhedged at $1,220, $1,300 and $1,380 an ounce.
Explanation of Solution
Given information:
Gold current price of gold is $1,300
The prices are volatile to $1,220 or $1,380 in the next month.
Company will bring 1,000 to market next month.
Calculation of total revenue:
When unhedged at the price of $1,220,
Therefore, unhedged revenue is $1,220,000
When unhedged at the price of $1,300,
Therefore, unhedged revenue is $1,300,000
When unhedged at the price of $1,380,
Therefore, unhedged revenue is $1,380,000
b)
To determine: Futures unhedged revenue.
Explanation of Solution
Calculation of futures hedged revenue:
When futures hedged at the price of $1,220
Therefore, futures hedged revenue is $1,310,000
When futures hedged at the price of $1,300,
Therefore, futures hedged revenue is $1,310,000
When futures hedged at the price of $1,380,
Therefore, futures hedged revenue is $1,310,000
c)
To determine: Put options-hedged revenue.
Explanation of Solution
Calculation of put options-hedged revenue:
When the gold price at $1,220
Therefore, put options hedged revenue is $1,190,000
When the gold price at $1,300
Therefore, put options hedged revenue is $1,190,000
When the gold price at $1,380
Therefore, put options hedged revenue is $1,270,000
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Chapter 26 Solutions
PRIN.OF CORPORATE FINANCE
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