XYZ Corporation is a coal miner. It takes one year to extract the coal, and XYZ pays $500 in mining expenses, paid at the end of the year. The price that it receives for its coal depends on market conditions. The risk manager is trying to avoid losses. Suppose the market price of coal is $480. Suppose the interest rate is 5% and there is a fair forward market.
a) Can XYZ guarantee a profit next year? If yes, what will the profit be, and exactly how can XYZ achieve it?
b) Suppose there are no coal derivatives. But there are cash settled natural gas derivatives. Could these be used to help XYZ? Why or why not?