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FRM Part I · FRM Exam Part I · Commodity Forwards and Futures

A jewelry maker expects to buy gold in three months and wants to protect against a price increase. Which position in gold futures is appropriate, and what is the main reason it reduces risk?

The jewelry maker should take a long futures position. If gold prices rise, the futures gain offsets the higher cost of buying gold in the spot market, so the net purchase price is more stable. A short position would worsen the exposure.

  1. ALong futures, because gains on the futures offset a higher purchase cost in the spot marketCorrect
  2. BShort futures, because gains on the futures offset a higher purchase cost in the spot market
  3. CLong futures, because losses on the futures offset a higher purchase cost in the spot market
  4. DShort futures, because the futures price always converges to a lower spot price

Explanation

A buyer of the commodity faces loss if prices rise, so a long hedge is used. If the spot price rises, the long futures position gains, offsetting the higher purchase cost. A short position would add to the loss in a rising market.

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