Cranked Coffee Company\'s cost of producing copper is about $3.95 per pound. The
ID: 2798847 • Letter: C
Question
Cranked Coffee Company's cost of producing copper is about $3.95 per pound. The current market price for copper is $4.74 per pound. The six-month futures price for copper is $4.94 per pound. At this selling price, the company can maintain its earnings growth. The company expects to produce 1,250,000 pounds of copper in this six months. (Note: Copper futures are traded at a standard size of 250,000 pounds.) Cranked Coffee places a hedge on its copper production in the futures market. When the contract comes due in six months, the spot price of copper is $3.36 per pound in the cash markets. Prices on the new six-month futures contracts in copper are $4.20 per pound. The net gain or loss in the futures market is ______.
$0
$5,250,000
-$737,500
$1,975,000
-$6,175,000
a.$0
b.$5,250,000
c.-$737,500
d.$1,975,000
e.-$6,175,000
Explanation / Answer
The company has to sell the produced copper in 6 months.
Hence it enters a contract to sell copper after 6 months at $4.94 which locks in the rate.
So after 6 months the company will receive 4.94 dollar for a pound of copper
After 6 months the spot rate = $3.36 which is less than what company will get as per contract. Hence it was profitable for the company to enter the contract
profit per pound = 4.94-3.36=$1.58
For 1,250,000 pounds, gain = 1.58*1250000=$1,975,000
hence option d is applicable