You have just been hired as the finance director of a firm that mines gold from a gold mine and sells gold on the world market. Production is stable, but you notice that the spot price of gold varies a lot.
(a) At your first meeting with the CEO you say that you plan to hedge the price of gold using futures contracts. The CEO says “No. There is no point in using futures. There is just as much chance that the price of gold in the future will be less than the futures price, as the chance that the price of gold will be greater than the futures price”. How do you address the CEO’s claim, and how to you make the case for using futures? (Hint: Make your answer short and to the point).
(b) Compare the following two strategies for hedging the price of gold: (i) Futures contract, and (ii) a collar based on gold options. (Hint: Make your answer short and to the point).