A farmer who has planted soybeans for November harvest estimates that in order t

Question

A farmer who has planted soybeans for November harvest estimates that in order to make a profit, he will have to sell his soybeans for $5.48/bushel. In May, cash soybeans are $5.48/bu and the November futures price is $5.76/bu. The farmer hedges his position in the futures market. By November, the cash price has declined to $4.83/bu and the November futures price is $5.10/bu. The farmer lifts his hedge and sells his soybeans at the prevailing price. a. Is this a short or long hedge? Explain. (5 points) b. Calculate the basis in May. Show your work (3 points) c. What is the basis in November? Show your work (3 points) d. Did the basis strengthen or weaken? Explain (5 points) e. What is the gain or loss in the futures market? Show your work (5 points) f. What was the net price received for his soybeans after hedging? Show your work (6 points)

Explanation / Answer

a. The farmer who planted soybeans would want to lock the future price that he would get for his produce, so he will sell or short hedge to protect against falling prices. The hedge locks in the price by taking the opposite position in the futures market (sell) to what he has (buy) in the cash market. If the sell hedge is in place, a drop in the price of soybean futures (and the value of cash canola) will make the growing or cash grain worth less, but the sell or "short" futures hedge will be worth more. The money lost in one market and the money made in the other will balance each other off very closely.

b. Basis is calculated as the difference between cash price and future price,

So, for May, basis = November futures price - May cash price = 5.76 - 5.48 = 0.28

c. Basis in November = November futures price - cash price in November = 5.10 - 4.83 = 0.27

d. Basis strengthens when the difference between cash price and future price decreases, in the case as the difference decreased from 0.28 to 0.27, so the basis has strengthened.

e. Since the price of futures contract has declined from $5.76/bushel to $5.10/ bushel, the gain in the futures market is of $0.66/bushel

f. Net price for soybean = cash price in Nov + Gain from future contract

Net price received = $4.83 + $0.66 = $5.49

Related Questions

Navigate

• Browse (All)
• Browse A
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.