Question

Suppose that it is january 15 now. A copper fabricator knows it will require 100,000 pounds of copper on May 15 to meet a certain contract. So he takes a long position in the future contract. At that time the spot price of copper is 140 cents per pound and the May futures price is 120 cents per pound. Each contract is for the delivery of 25,000 pounds of copper. If the cost of copper on May 15 is 125 cents per pound, what is the effective price this copper fabricator pays per pound?

a. Around 125 cents
b. Around 105 cents
c. Around 140 cents
d. Around 120 cents
e. Around 115 cents

Answer 1

The effective price the copper fabricator pays per pound is 125 cents.

Step-by-step explanation:

To calculate the effective price the copper fabricator pays per pound, we need to consider the profit or loss from the futures contract. The copper fabricator takes a long position in the futures contract at 120 cents per pound, while the spot price is 140 cents per pound. This means that for each pound of copper, the fabricator is making a profit of 20 cents (140 - 120).

Since each futures contract is for the delivery of 25,000 pounds of copper, the total profit from the futures contract is 25,000 pounds x 20 cents = 5,000 dollars. However, the copper fabricator needs 100,000 pounds of copper and the futures contract only covers 25,000 pounds, so the fabricator needs to enter into 4 futures contracts.

Therefore, the total profit from the futures contract is 5,000 dollars x 4 contracts = 20,000 dollars. This profit offsets the higher price paid for the copper on May 15, so the effective price the copper fabricator pays per pound is the same as the spot price on that day, which is 125 cents per pound. Therefore, option a. Around 125 cents is the correct answer.