FRM Part I · FRM Exam Part I · How Do Firms Manage Financial Risk?
A manufacturer wants protection against a rise in copper prices while keeping the benefit if prices fall, and accepts paying an upfront cost. Which instrument fits this need?
A long call option on copper fits. It caps the purchase price if copper rises, yet lets the firm buy at the lower market price if copper falls, at the cost of the premium. Forwards and futures fix the price and forgo favourable moves.
- ALong copper forward contract
- BLong copper futures contract
- CLong call option on copperCorrect
- DShort put option on copper
Explanation
A long call sets a cap on the purchase price while allowing the firm to buy at the lower market price if prices fall; the premium is the upfront cost. Forwards and futures lock the price and remove the downside benefit. A short put adds downside risk and does not cap the cost.
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