Question

Now is September. Laura will sell 10,000 bushels of corns in December. In September, the December corn futures are selling for $6 per bushel. To hedge her corn price risk, she sells 10,000 bushels of December corn futures. Given a positive sign represents a cash inflow and a negative sign represents a cash outflow, which of the following is CORRECT if the corn price goes up to $7 per bushel in December?

A) Laura's payoff in the spot market in December is $60,000.

B) Laura's total payoff from both the spot market and futures market in December is $60,000.

C) Laura's payoff in the futures market in December is $10,000.

D) Laura's payoff in the futures market in December is $70,000.

Group of answer choices

Answer 1

Futures is one of the derivative market in hedging your risk. Laura which is expected to be an agriculturist ,the risk faced by her is the corn prices going down. So she sell the Dec futures in Sept @ 6 per bushel. By doing so, she has effectively frozen her net payoff from 10,0000 @ 6 per bushel i.e 60,000.

If the future price goes up by 7$ per bushel, that means there will be a loss of 70,000 in futures market and also she will earn extra 70,000 on physically selling the corn. Effectively again bringing her total payoff to 60,000 (60000 -70000 + 70000).

Hence come what may, her net payoff from both the market shall be 60,000

Correct option b