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Market and Limit Order Etc.

You have a commitment to supply 10,000 oz of gold to customer in three months' time at some specified price and are considering hedging the price risk that you face.

In each of the following scenarios describe the kind of order (market, limit, etc) that you would use and why you would use that.

a. You are certain you wish to hedge and want to take up a futures position regardless of the price.

b. Gold futures prices have been on an upward trend in recent days and you are not sure you want to enter the market right now. However, if the trend continues, you are afraid you will be locked into too high a price. Weighing the pros and cons, you decide you want to take a futures position if the price continues to trend up and crosses $370 per oz.

c. Consider the same scenario as in b, but now suppose also that you expect a news announcement that you think will drive gold prices sharply lower. If matters turn out as you anticipate, you want to enter into a futures position at a futures price of $350 oz or lower. However you recognize there is a probability the news announcement may be adverse and gold prices may continue to trend up. In this case you want to buy futures and exit if the prices touch $370 oz.

d. You want to institute a hedge only if you can obtain a gold futures price of $365 oz or less.

e. gold futures prices have been on a downward trend in the last few days. You are hoping this continues but dont anticipate prices will fall too much below $362/oz so you are willing to take the best price you can get once prices are at $364/oz.

Please discuss answer in detail.

Solution Preview

Scenario A
In this scenario the supply of gold is going to be hedged and take up future position without considering price. In this scenario a market order is appropriate since the supply of gold will take up future position regardless of position. SEC (2011) provides that a market order sells a contract or stock at the best available price. This type of order is appropriate for the scenario since it does guarantee the price at which the order will be executed and therefore risks the fact that the order could result in different price. This means that prices will be hedged since the order will be executed at the best price available in the market. The order does not specify the price thus does not match the market price since and the price may shift by the time the order for gold is executed.

Scenario B
The price of gold is increasing but may lock me into too a price thus the decision is to take up future position if the price gets to $ 370 per oz. in this case a limit order is appropriate because it provides that the order can be executed at a specific price or an improved price. When supplying the gold a limit order enables one to execute the contract at the specified price or at a price which ...

Solution Summary

The solution discusses mark and limit order etc.