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Coca-Cola uses sugar to produce its soft drinks and is concerned about price volatility in the sugar market in the future. Which of the following is a valid strategy for hedging this exposure?

a. "Sell" sugar futures contracts (i.e., take a "seller's" position in a futures contract)
b. "Buy" sugar futures contracts (i.e., take a "buyer's" position in a futures contract)
c. Enter into a forward contract in which the firm agrees to sell sugar at a set price in the future
d. Enter into a forward contact in which the firm agrees to buy sugar at a set price in the future.
e. Both b and d

1 Answer

3 votes

Final answer:

Coca-Cola can hedge against sugar price volatility by either buying sugar futures contracts or entering into a forward contract to purchase sugar at a set price in the future. Both these strategies allow the company to lock in a purchasing price and avoid the risk of paying higher prices due to market fluctuations.option e is correct answer.

Step-by-step explanation:

Hedging Strategies for Coca-Cola's Sugar Price Volatility

When considering hedging strategies for Coca-Cola to mitigate the risk of sugar price volatility, it's important to understand the two main financial instruments that can be used: futures contracts and forward contracts. Given that Coca-Cola requires sugar for its soft drink production, the company would be looking to secure a stable and predictable price for sugar in the future to avoid unexpected costs due to price fluctuations.

Therefore, the valid strategies for Coca-Cola to hedge against rising sugar prices would include:

  • "Buy" sugar futures contracts (i.e., taking a "buyer's" position in a futures contract), which means that Coca-Cola would agree to purchase sugar at a predetermined price on a specified future date, regardless of the fluctuating market price.
  • Enter into a forward contract in which the firm agrees to buy sugar at a set price in the future. This is a customized contract between two parties, where Coca-Cola would agree on the price and quantity of sugar to be purchased at a date in the future, effectively setting the cost in advance and avoiding uncertainty.

Both strategies provide a hedge against the risk of sugar prices increasing since they allow Coca-Cola to lock in a specific purchasing price. Hence, the correct answers are that Coca-Cola should either "Buy" sugar futures contracts or enter into a forward contract to purchase sugar at a predetermined price, making options b and d both right strategies.

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