In May, Mr. Smith planted a wheat crop, which he expects to harvest in September. He...

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In May, Mr. Smith planted a wheat crop, which he expects toharvest in September. He anticipates the September harvest to be10,000 bushels and would like to hedge the price he can get for hiswheat by taking a position in a September wheat futurescontract.
a. Explain how Mr. Smith could lock in the price he sells hiswheat with a September wheat futures contract trading in May at f0= $4.50/bu. (contract size of 5,000 bushels).
b. Show in a table Mr. Smith’s revenue at the futures’expiration date from closing the futures position and selling10,000 bushels of wheat on the spot market at possible spot pricesof $4.00/bu., $4.50/bu., and $5.00/bu. Assume no quality, quantity,or timing risk.
c. Give examples of the three types of hedging risk in thecontext of problem b.
d. How much cash or risk?free securities would Mr. Smith have todeposit to satisfy an initial margin requirement of 5%?

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3.6 Ratings (287 Votes)

aFutures price refers to the price of financialor consumption asset which is computed as taking base of the spotprice of such asset as well as taking into account of the othercosts Future price shall be computed by taking interest rate intoaccount for the maturity period given in the case If the computedfuture price is not equal to the actual price in the market See Answer

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In May, Mr. Smith planted a wheat crop, which he expects toharvest in September. He anticipates the September harvest to be10,000 bushels and would like to hedge the price he can get for hiswheat by taking a position in a September wheat futurescontract.a. Explain how Mr. Smith could lock in the price he sells hiswheat with a September wheat futures contract trading in May at f0= $4.50/bu. (contract size of 5,000 bushels).b. Show in a table Mr. Smith’s revenue at the futures’expiration date from closing the futures position and selling10,000 bushels of wheat on the spot market at possible spot pricesof $4.00/bu., $4.50/bu., and $5.00/bu. Assume no quality, quantity,or timing risk.c. Give examples of the three types of hedging risk in thecontext of problem b.d. How much cash or risk?free securities would Mr. Smith have todeposit to satisfy an initial margin requirement of 5%?