Why hedging with futures contracts may not be perfect

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Reference no: EM131965277

In February, a gold mining company expects to sell 10,000 ounces of gold in May this year. Unwilling to take any risk, it has decided to hedge this position by using the June gold futures contracts traded on the New York Mercantile Exchange. One contract has a standardized size of 100 ounces. The current spot price is $1,260/oz and the price of the June futures contracts is $1,270/oz. Please answer the following questions:

(1) Should the company take a long or short position in the futures market? Explain.

(2) How many contracts are needed?

(3) Assume that in May, the spot price drops to $1,240 and the futures price becomes $1,255/oz. Evaluate the hedging result. In other words, how much can the company actually receive from the sale of 10,000 ounces of gold and the futures position?

(4) Why hedging with futures contracts may not be perfect?

Reference no: EM131965277

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