In May, Green Grains Inc. placed a long futures positions to hedge against a pos
ID: 2798846 • Letter: I
Question
In May, Green Grains Inc. placed a long futures positions to hedge against a possible increase in the price of wheat, a key raw material in the production of flour. Based on the selling price that Green Grains earns from its customers, the maximum price that it can pay for wheat is $7.50 per bushel to break even. You also have the following information and assumptions: (1) The current spot price of wheat is $5.63 per bushel, and the September futures price of the commodity is $6.38 per bushel. (2) At $6.38 per bushel, the company will easily break even and make some profit, so it wants to lock in this purchase price for delivery in September. (3) Wheat futures contracts trade in a standard size of 5,000 bushels. To meet its production requirements, Green Grains buys 20 future contracts. In September, the spot price of wheat rose to $9.00 per bushel, and the price of wheat futures rose to $9.60 per bushel. Based on your understanding of the long hedge strategy, the company earns a net profit of ______.
$112,000
$316,000
$480,000
$0
$134,400
a.$112,000
b.$316,000
c.$480,000
d.$0
e.$134,400
Explanation / Answer
Long position Futures contract means that the company will buy the underlying asset (Wheat) at the Futures contract price i.e., $6.83 per bushel on the expiry day in september. When you are buying futures you are actually not receiving the commodity, you are just trading to profit on price fluctuations. The company would sell the futures @spot price of $9. Also, to meet its customer @$9 per bushel spot price.
Gain on futures trading = ($9 - $6.83) x 5000 bushels per contract x 20 contracts = $262000
Loss on selling to Customer = ($9 - $7.50) x 5000 x 20 = $150000
Total net profit = $262000 - $150000 = $112000
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