On March 1 a commodity’s spot price is $60 and its August futures price is $59. On July 1 the spot price is $64 and the August futures price is $63.50. A company entered into futures contracts on March 1 to hedge its purchase of the commodity on July 1. It closed out its position on July 1 through reverse trade. What is the effective price (after taking account of hedging) paid by the company?
On March 1, the Company takes a long Future Position by buying Futures at $59.
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On July 1,The Company closes its Future position at $63.5 to hedge its Purchase of Commodity at $64
Therefore Gain on Futures = 63.5- 59 = $ 4.5
Cost paid by Company to buy Commodity on July 1 = Spot Rate = $64.
Therefore, Effective Price (After taking account of Hedging) paid by the Company = 64 – 4.5 = $ 59.5
Ans:Effective Price (After taking account of Hedging) paid by the Company = $ 59.5