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FRM Part I · FRM Exam Part I · Using Futures for Hedging

A jewelry manufacturer expects to buy gold in three months and wants to protect against a price increase. Which futures position implements this hedge?

The manufacturer should take a long position in gold futures. It needs to buy gold later, so rising prices hurt it, and a long futures position gains when prices rise, offsetting the higher purchase cost. This is called a long or buying hedge.

  1. AShort gold futures
  2. BLong gold futuresCorrect
  3. CLong gold futures combined with a short position in the spot market
  4. DShort gold futures combined with a long position in the spot market

Explanation

A firm that will need to buy an asset in the future is exposed to price increases. A long futures position gains when prices rise, offsetting the higher purchase cost. This is a long (buying) hedge, so the short futures position is wrong because it would lose when prices rise.

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