Suppose you have $8,000 to invest in the copper market. To leverage your exposur

Question

Suppose you have $8,000 to invest in the copper market. To leverage your exposure to this market, you want to buy as many one- year copper futures contracts as you can afford based on the margin requirement. Copper is selling at $3 a pound and the margin requirement for a futures contract for 25,000 pounds of copper is $8,000 Instructions: Enter your responses rounded to the nearest whole number for quantities, to the nearest tenth for percentages (one decimal place), and to the nearest whole number for dollar amounts. a. Calculate your return if copper prices rise to $3.10 a pound. With $8,000, you can afford to purchase copper futures contract(s). At $3 a pound, this is worth $ [-] The contract specifies that you will take delivery of 25,000 pounds at $ has risen to $3.10 by then, you make a profit of S a pound in one-year's time. If the price in the market on the $margin you posted. This represents a return of % on your investment. b. How does this compare with the return you would have made if you had simply purchased $8,000 worth of copper and sold it a year later? If you purchased copper directly at $3 a pound, you could have affordedpounds. If you sold it one year later for $310, you would have gained $, a return of % C. Compare the risk involved in each of these strategies. Suppose, for example, your hunch about copper prices was incorrect and the price of copper fell to $2.90. You would have lost $ over the year. In comparison, if you bought the copper at $3 and after a year you sold it at $2.90, you would have lost only $

Explanation / Answer

a) Calculate your return if copper prices rise to $3.10 a pound.

With $8,000, you can afford to purchase one copper futures contract. At $3 a pound, this is worth $75,000 ($3*25,000 = $75,000)).

The contract specifies that you will take delivery of 25,000 pounds at $3 a pound in one-years’ time. If the price in the market has risen by then to $3.10, you make a profit of $2,500 [($3.1-$3)*25,000 =$2,500)] on the $8,000 margin you posted.

This represents a return of 31.25% [($2,500/$8,000)*100 = 31.25%] on your investment.

b) How does this compare with the return you would have made if you have simply purchased $8000 worth of copper and sold it a year later?

If you purchased copper directly at $3 a pound, you could have afforded 2,667 pounds ($8,000/$3 =2,667).

If you sold it one year later for $3.10, you would have gained $267 [($3.1-$3)*2,667 = $266.7], a return of 3.33% [($267/$8,000)*100 = 3.33%].

c) Compare the risk involved in each of these strategies

Suppose, for example, your hunch about copper prices was incorrect and the price of copper fell to $2.90. You would have lost $2,500 [($2.9-$3)*25,000 = -$2,500)] over the year.

In comparison, if you bought the copper at $3 and after a year you sold it at $2.90; you would have lost only $267 [($2.9-$3)*2,667 = - $266.7]

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