Futures : A company wants to hedge against a price drop...

Question

A company wants to hedge against a price drop in oil. If the current price of oil is $60 and the futures price for delivery in 3 months is $62, what is the profit/loss from the futures contract if the price drops to $55 at expiration?

A. $5 profit

B. $5 loss

C. $7 profit

D. $7 loss

E. No profit or loss

• Answer

  D

• Step-by-step solutions

  Step 1: Highlight Relevant Information & Define Key Variables

  • Current price of oil: $60

  • Futures price: $62

  • Price at expiration: $55

  Step 2: Determine Profit/Loss

  The profit or loss from the futures contract is calculated as:
  Profit/Loss = Futures Price – Spot Price at Expiration
  Profit/Loss = $62 – $55 = $7 profit

  However, since the company is holding a short position to hedge, a decrease in price results in a loss on the contract.
  So, the company incurs a $7 loss.

  Step 3: Conclusion

  The correct answer is B, as the company loses $7 on the futures contract when the price drops to $55.