Question

Coolmist produces high-quality juices and competes for head-on with the large national brands. Because of this stiff competition, they find it very difficult to raise the price of their juice. Oranges are a key raw material. As a rule, the risk managers of Coolmist are NOT interested in designing an expensive risk management insurance strategy aimed at protecting their profit margins against small changes in the price of oranges. However, they are very interested in designing a cheaper risk management strategy that will protect margins against large changes in the price of oranges. However, they are very interested in designing a cheaper risk management strategy that will protect margins against upward price spikes on oranges.
Given this scenario, what financial engineering strategy would be most beneficial to Coolmist?
a. Buy in-the-money puts on oranges
b. Buy out-of-the-money calls on oranges
c. Buy out-of-the-money puts on oranges
d. Buy in-the-money calls on oranges
e. Buy out-of-the-money straddles on oranges
f. Buy in-the-money straddles on oranges

Answer 1

Answer:

d. Buy in-the-money calls on oranges

Explanation:

A call option is an option to buy a product or asset at a stated price at a later date. The risk of call option is capped at premium for buying the option. The best financial engineering strategy for Coolmist is to buy in the money calls on oranges. This gives Coolmist a right to buy oranges at predetermined price at a later date. This minimizes the risk of upward price strike of oranges.