1. You are a sugar dealer anticipating the purchase of 250,000 pounds of sugar i
ID: 2666711 • Letter: 1
Question
1. You are a sugar dealer anticipating the purchase of 250,000 pounds of sugar in three months. You are concerned that the price of sugar will rise, so you take a long position in sugar futures. Each contract covers 112,000 pounds, and so, rounding to the nearest contract, you decide to go long in two contracts. The futures price at the time you initiate your hedge is 19.56 cents per pound. Three months later, the actual spot price of sugar turns out to be 20.65 cents per pound and the futures price is 20.85 cents per pound.a. Determine the effective price at which you purchased your sugar. How do you account for the difference in amounts for the spot and hedge positions?
Explanation / Answer
You are going to purchase 250,000 pounds of sugar in the future. If you are going long the future you are essentially locking in buying that sugar at 19.56 cents per lb in three months. So this means you will pay ($0.1956/lb x 112,000 lb x 2 contracts) = $43,814.40 in 3 months for the sugar. 3 months later you STILL will only pay $43,814.40 for the sugar. Remember that futures contracts are set in stone; you have to pay what the contract price was not matter what happens to the spot price as time passes. Because the spot price what you must compare your contract price too, you use it to calculate your gain or loss. The spot price is ($0.2065/lb x 112,000 x 2) = $46,256.00. Because you now OWN 2 contracts, you could sell them at the spot price ($46,256.00) while it only cost you the ($43,814.40) so you would gain $,2441.60. Hope this helps!
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