Price risk management in the copper market using commodity derivatives and options strategies

Metals price risk management is a key issue related to financial risk in metal markets because of uncertainty of commodity price fluctuation, exchange rate, interest rate changes and huge price risk either to metals’ producers or consumers. Thus, it has been taken into account by all participants in metal markets including metals’ producers, consumers, merchants, banks, investment funds, speculators, traders and so on. Managing price risk provides stable income for both metals’ producers and consumers, so it increases the chance that a firm will invest in attractive projects. The purpose of this research is to evaluate risk management strategies in the copper market. The main tools and strategies of price risk management are hedging and other derivatives such as futures contracts, swaps and options contracts. Hedging is a transaction designed to reduce or eliminate price risk. Derivatives are financial instruments, whose returns are derived from other financial instruments and they are commonly used for managing financial risks. Although derivatives have been around in some form for centuries, their growth has accelerated rapidly during the last 20 years. Nowadays, they are widely used by financial institutions, corporations, professional investors, and individuals. This project is focused on the over-the-counter (OTC) market and its products such as exotic options, particularly Asian options. The first part of the project is a description of basic derivatives and risk management strategies. In addition, this part discusses basic concepts of spot and futures (forward) markets, benefits and costs of risk management and risks and rewards of positions in the derivative markets. The second part considers valuations of commodity derivatives. In this part, the options pricing model DerivaGem is applied to Asian call and put options on London Metal Exchange (LME) copper because it is important to understand how Asian options are valued and to compare theoretical values of the options with their market observed values. Predicting future trends of copper prices is important and would be essential to manage market price risk successfully. Therefore, the third part is a discussion about econometric commodity models. Based on this literature review, the fourth part of the project reports the construction and testing of an econometric model designed to forecast the monthly average price of copper on the LME. More specifically, this part aims at showing how LME copper prices can be explained by means of a simultaneous equation structural model (two-stage least squares regression) connecting supply and demand variables. A simultaneous econometric model for the copper industry is built: {█(Q_t^D=e^((-5.0485))∙P_((t-1))^((-0.1868) )∙〖GDP〗_t^((1.7151) )∙e^((0.0158)∙〖IP〗_t ) @Q_t^S=e^((-3.0785))∙P_((t-1))^((0.5960))∙T_t^((0.1408))∙P_(OIL(t))^((-0.1559))∙〖USDI〗_t^((1.2432))∙〖LIBOR〗_((t-6))^((-0.0561))@Q_t^D=Q_t^S )┤ P_((t-1))^CU=e^((-2.5165))∙〖GDP〗_t^((2.1910))∙e^((0.0202)∙〖IP〗_t )∙T_t^((-0.1799))∙P_(OIL(t))^((0.1991))∙〖USDI〗_t^((-1.5881))∙〖LIBOR〗_((t-6))^((0.0717) Where, Q_t^D and Q_t^Sare world demand for and supply of copper at time t respectively. P(t-1) is the lagged price of copper, which is the focus of the analysis in this part. GDPt is world gross domestic product at time t, which represents aggregate economic activity. In addition, industrial production should be considered here, so the global industrial production growth that is noted as IPt is included in the model. Tt is the time variable, which is a useful proxy for technological change. A proxy variable for the cost of energy in producing copper is the price of oil at time t, which is noted as POIL(t ) . USDIt is the U.S. dollar index variable at time t, which is an important variable for explaining the copper supply and copper prices. At last, LIBOR(t-6) is the 6-month lagged 1-year London Inter bank offering rate of interest. Although, the model can be applicable for different base metals' industries, the omitted exogenous variables such as the price of substitute or a combined variable related to the price of substitutes have not been considered in this study. Based on this econometric model and using a Monte-Carlo simulation analysis, the probabilities that the monthly average copper prices in 2006 and 2007 will be greater than specific strike price of an option are defined. The final part evaluates risk management strategies including options strategies, metal swaps and simple options in relation to the simulation results. The basic options strategies such as bull spreads, bear spreads and butterfly spreads, which are created by using both call and put options in 2006 and 2007 are evaluated. Consequently, each risk management strategy in 2006 and 2007 is analyzed based on the day of data and the price prediction model. As a result, applications stemming from this project include valuing Asian options, developing a copper price prediction model, forecasting and planning, and decision making for price risk management in the copper market.

"Brethren upon the same level" : membership and class in Calumet's Masonic Lodge

The Keweenaw Peninsula of Upper Michigan was a ethnic conglomerate of cultures and ideas, with people attracted to the area by the mineral wealth found along the Copper Range. The center of copper mining from the mid 1860s to 1968 was in the vicinity of Calumet Township, home to the world-famous Calumet and Hecla Mining Company. The township depended on the mines and the company’s president Agassiz’s strove to make the area a “model community,” that included groups such as the Free and Accepted Masons. Men from myriad backgrounds arrived in Calumet from the British Isles, Germany, Finland, Eastern and Southern Europe and the Eastern United States. As in other communities from the time period these men formed common interest groups like Masonic Lodge 271, which received its charter in 1870. Gentlemen joined with merchants and craftsmen. They became “brethren upon the same level,” and were elevated to the status of Master Mason. This symbolic transformation within the Lodge removed the men from the “profane world” outside the sanctity of Masonry, and in the ritualistic transformation of the meeting they were reborn into Masonry’s sacred mysteries. Masonry acted as a means of moral guidance to men and gave them access to a larger social and economic community through a common connection of brotherhood. As the candidates moved through the three Blue Lodge degrees of Entered Apprentice, Fellowcraft, and Master Mason they saw each other as “brethren upon the same level” – all economic classes equal within the Masonic Lodge. To examine equality within Lodge 271, this study sorted workers into classes to allow a comparison of Lodge 271’s membership. Possibly a comparison between other lodges can be drawn from the membership. The Union Building in Calumet, MI will be examined for its role in the ritualistic transformation of Masonry as it housed Masonic activities and transformations. This transformation brought men into the lodge of brothers. While Masonry professed equality between members however, to what extent did the membership of the lodge reflect this between the brethren? To what extent did economic class determine who was made “brethren upon the same level? 1 Arthur Thurner, Calumet Copper and People: History of a Michigan Mining Community, 1864-1970 (Hancock, MI: Book Concern, 1974), 122.