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Woodsynergy Case Inc.

Essay by   •  November 16, 2012  •  Case Study  •  248 Words (1 Pages)  •  2,383 Views

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1. Selling futures contracts as a hedging strategy means that the firm is able to actually deliver the lumber. This means that the firm is a lumber supplier. How is the firm affected by price changes of lumber? If lumber prices decrease, then the supplier's revenue will decrease, as well. It can protect itself from the risk of declining prices, by selling lumber futures. This will essentially lock the buyer into paying a specific price in the future. If lumber prices fall, the firm will experience a loss in the spot market, but it will be offset by the gain on the short position (selling the futures contract).

2. Since the firm is buying call option, this means that the firm must be a consumer of pork bellies. A call option gives the buyer the right to buy pork bellies at a specific price. If the price of pork bellies decreases, this is good because they will have to pay less, however, their call option will expire worthless and they will lose the premium paid for the option. On the other hand, if the price of pork bellies increases, then the consumer will exercise the option and will be able to buy at a lower price. Options can be viewed as an "insurance policy". You pay a premium to protect from unfavorable changes in price. However, if the change in price is favourable, then you don't need to exercise the option and you only lose the premium paid.

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