The company will have to purchase the gold and if it

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Financial Management: Theory & Practice
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Chapter 23 / Exercise 23-1
Financial Management: Theory & Practice
Brigham/Ehrhardt
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The company will have to purchase the gold and if it wants to protect itself from large price increases it can take a long position in a gold futures contract today. If gold prices fall rather than rising, the company can sell an equivalent contract before the maturity date. If prices rise,the company can take delivery of the gold at a more favorable price than the spot price at the time of maturity.Speculators dominate the futures market. Only 1% to 3% of futures market participants actually plan to take delivery of the asset. The rest are speculators who plan to offset their positions prior to expiration of the contract. A speculator will take a long position if he expects prices to increase. As the value of the futures contract rises, the holder of the long position gains and the holder of the short position loses. The speculator can sell the contract for more than he paid in this case. Speculators buy futures contracts rather than the underlying assets because transaction costs are much lower. The speculator also benefits from leverage since only a small percentage of the total contract value is required to be posted as margin.Feedback: This question tests whether the student understands the main characters in the futures markets, the reasons they use the markets, and the role each of them plays in the market's operation.AACSB: Reflective ThinkingBlooms: UnderstandDifficulty: IntermediateTopic: Futures22-85
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Financial Management: Theory & Practice
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Chapter 23 / Exercise 23-1
Financial Management: Theory & Practice
Brigham/Ehrhardt
Expert Verified

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