Explanation:
This is a long hedge on a future purchase of copper.
$2.90$3.00If the basis converges to zero as expected, the futures gain offsets the higher purchase price, so the net cost is:
For a long hedge:
So the false statement is D.
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Q-710.3. It is currently March, and a company plans to purchase copper in December. The spot price of copper is $2.80 in March while the December futures contract price is $2.90; i.e., the forward curve is "in contango" with a -$0.10 basis. A company employs a long hedge on the assumption that the futures price will converge to the spot price in December when the contract matures. The company's future "net cost" will include the cost to purchase copper at the future prevailing spot price plus (or minus) the gain (or loss) on the futures position. The company anticipates the spot/futures price will be $3.00 in December. The company goes long four contracts, each for 25,000 pounds of copper.
http://www.cmegroup.com/trading/metals/base/copper_contract_specifications.html
Under these assumptions, each of the following statements is true EXCEPT, which is false?
A
If the basis unexpectedly weakens, the company's net cost will be less than $290,000; i.e., the company will be better off than it planned
B
If the basis unexpectedly strengthens, the company's net cost will be more than $290,000; i.e., the company will be worse off than it planned
C
If the basis converges to zero as expected, the company's net cost will be $290,000 regardless of whether the spot price increases or decreases
D
If the forward curve unexpectedly shifts to backwardation (aka, inverted forward curve), the company's net cost will be less than $290,000; i.e., the company will be better off than it planned