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FRM Part I · FRM Exam Part I · Introduction to Derivatives

A gold mining company expects to sell 10,000 ounces of gold in six months and is concerned that the gold price may fall. Which action best represents a hedging use of derivatives?

The miner should sell gold futures on 10,000 ounces. It is naturally long gold, so a short futures position gains when gold falls and offsets the lower sale proceeds. Buying futures would add to the exposure, and over-hedging would introduce speculation.

  1. ABuy six-month gold call options on 10,000 ounces to speculate on a price rise
  2. BSell six-month gold futures contracts covering 10,000 ouncesCorrect
  3. CBuy six-month gold futures contracts covering 10,000 ounces
  4. DSell gold futures covering 20,000 ounces to profit from a price fall

Explanation

The company is naturally long gold, so it needs a short futures position to offset losses from a price decline. Buying futures would double its exposure. Selling 20,000 ounces would over-hedge and create a net short speculative position.

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