Question

On february 1, year 1, nickel mining co. (nmc) decided to use a forward contract to hedge the price of nickel on 150,000 pounds of nickel, which represents 30% of its annual sales. currently, the spot price is $6 per pound. nmc will settle the contract on july 31, year 1. the company has entered into a forward contract to deliver 150,000 pounds of nickel on july 31, year 1, at a forward price of $7 per pound. which of the following statements best describes what this contract means for nmc?

a) nmc will purchase 150,000 pounds of nickel on july 31, year 1, and will have to pay $1,050,000.
b) nmc will deliver 150,000 pounds of nickel on july 31, year 1, and receive cash of $900,000 on delivery.
c) nmc will deliver 150,000 pounds of nickel on july 31, year 1, and receive the higher of the $7 per pound or the spot price on that date per pound.
d) nmc will deliver 150,000 pounds of nickel on july 31, year 1, and receive $1,050,000 on delivery.

Answer 1

The correct interpretation of NMC's forward contract is that they will deliver 150,000 pounds of nickel and receive $1,050,000 on the settlement date, July 31, year 1, as per the terms of the forward contract.

Step-by-step explanation:

On February 1, year 1, Nickel Mining Co. (NMC) decided to use a forward contract to hedge the price of nickel on 150,000 pounds of nickel, representing 30% of its annual sales. The current spot price is $6 per pound, and NMC will settle the contract on July 31, year 1. The company has entered into a forward contract to deliver 150,000 pounds of nickel at a forward price of $7 per pound.

The correct statement that describes what this contract means for NMC is (d): NMC will deliver 150,000 pounds of nickel on July 31, year 1, and receive $1,050,000 on delivery. This outcome is because the forward contract is an agreement to sell a specific quantity of a commodity (in this case, nickel) at a predetermined price on a set date in the future, regardless of the spot market price at that time.