It is May, and farmer will soon plant her sorghum. The sorghum will be harvested

Question

It is May, and farmer will soon plant her sorghum. The sorghum will be harvested in November. She wants to hedge her sorghum; however there are no sorghum futures contracts available in the current market. Explain how she can cross-hedge her sorghum and why the cross-hedge works. (hint: both corn and sorghum are used as competitive ingredients in livestock feed production) a. Explain the effectiveness of this cross-hedge if the cash price of sorghum to fall in November b. Explain the effectiveness of this cross-hedge if the cash price of sorghum to rise in November.

Explanation / Answer

a). The farmer can cross-hedge sorghum with the farmers in the corn market. The cross-hedging could be beneficial to the sorghum's farmer if the future price of sorghum falls, and this would mean that the farmer recieved the same quantity of corn has was mentioned before in the contract. Thus, the value of the corn that he recieves will be more than the value of sorghum.

b). If the price of sorghum rises in November, then the Sorghum farmer will be at a loss. This is because the farmer of Sorghum had contracted his yield for corn at a value which was higher than the current value of Sorghum. Thus rise in price of Sorghum would lead to loses for Sorghum's farmer.

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