A farmer hedges his expected crop of 80,000 bushels of Corn with a hedge ratio:

Question

A farmer hedges his expected crop of 80,000 bushels of Corn with a hedge ratio: h = 1. NF = 5,000 bushels. Harvest is NOV, so the farmer uses the DEC futures with: F0,DEC = $3.20/Bushel.

Part 1 Use a time table to describe the hedge and its result in NOV;

SNOV = $2.95/bushel and FNOV, DEC = $3.00/bushel. Calculate the selling price.                                      

Part 2 Use a new time table to describe the hedge and its result in NOV:                  

SNOV = $3.95/bushel and FNOV, DEC = $4.00/bushel. Calculate the selling price.

Explanation / Answer

Since hedge ratio is 1, so equal amount of futures need to be bought

One contract has 5000 bushels.

SO no of the contract required to hedge = 80000/5000 = 16

Part1 :

Spot price Nov = $2.95/bushel

Future spot price in Dec = $3.20

SInce FNOV,Dec = $ 3.00/bushel which is higher than the futures price of dec in Nov.

He should be selling these in futures spot market

Part2 :

Spot price Nov = $3.95/bushel

Future spot price in Dec = $3.20

SInce FNOV,Dec = $ 4.00/bushel

He should be buying the futures for the crop as futures price is higher than the expected price in future

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