Company A enters into a forward contract to purchase 16,000 barrels of oil at $48/barrel in 6 months. What is the net gain or loss if the spot price of oil is $53/barrel at expiration?
Question
Company A enters into a forward contract to purchase 16,000 barrels of oil at 53/barrel at expiration?
Solution
To calculate the net gain or loss, we first need to understand what a forward contract is. A forward contract is a customized contract between two parties to buy or sell an asset at a specified price on a future date.
In this case, Company A has agreed to buy 16,000 barrels of oil at $48/barrel in 6 months. This is the forward price.
The spot price of oil at expiration is $53/barrel. This is the price of the oil in the market at the expiration of the contract.
The net gain or loss can be calculated by subtracting the forward price from the spot price, and then multiplying by the number of barrels.
Step 1: Calculate the difference between the spot price and the forward price. 48/barrel (forward price) = $5/barrel
Step 2: Multiply the result by the number of barrels. 80,000
So, if the spot price of oil is 80,000. This is because they agreed to buy the oil at a lower price than what it is worth at the expiration of the contract.
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