Question

Hanson is concerned the price of steel will increase in the next six months and wishes to use steel futures to lock-in a profit from the sale of the tanks, which will require the purchase of 40 tons of hot-rolled coiled steel4 . How can he do this and how many futures does he need?

Answer 1

Hanson can lock in a profit for the tanks by purchasing steel futures contracts, which act as a hedge against price increases. Each contract has a standardized size (e.g., 20 tons), so Hanson would need to buy enough contracts to cover the 40 tons required.

Step-by-step explanation:

Hanson can use steel futures to hedge against the potential price increase of steel in the next six months. To lock in a profit for the sale of tanks requiring 40 tons of steel, Hanson would need to calculate the size of futures contracts and purchase an appropriate number of contracts to cover the 40 tons. Typically, the size of a single steel futures contract is standardized (for example, 20 tons per contract for hot-rolled coil steel futures on some exchanges). Hanson would need to purchase two of these contracts to cover the 40 tons needed if each contract represents 20 tons of steel. By doing so, Hanson will effectively 'fix' the price at which he can buy steel, regardless of market fluctuations, ensuring his input costs remain stable and a profit can be locked in for the future sale of the tanks.