The current price of gold is $1,600 per troy ounce. There are no storage costs.

Question

The current price of gold is $1,600 per troy ounce. There are no storage costs. The risk free rate of interest is 5% continuously compounded.

Please help me with the answers for all the questions.

(a) What is the forward price of gold with delivery in 3 months?

(b) Calculate the cost of a collar, with 3 months to delivery, where the strike of all options used is 1620.126. The annual standard deviation of the gold price is 20%.

(c) Compare the two hedging strategies based on your answer in (a) and (b).

Explanation / Answer

(1) Forward Price = Today's Price * 1+(Risk free return/100) * N/12

1600*1.05*3/12

= 1620

(2) Annual SD = 1600*20% = 320

SO 3 Month SD = 320*3/12= 80

cost of collar = 80-20.126 =$59.874

(3) hedging strategy (b) i.e. option is better rather than (a) i.e. Forward however there is risk in option

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