Question

TastyKake Baking Company uses corn syrup for the sweetener in its cakes and pies. The problem is corn syrup prices gyrate significantly causing production costs to be volatile. TastyKake wants to maintain a stable selling price for its customers and stable profit margins so it employs futures contracts to hedge price risk. Corn syrup futures contacts are very illiquid because they are thinly traded causing the company to hedge it's production costs using raw sugar cane no. 11 futures contracts. A pound of no. 11 raw sugar roughly substitutes for a pound of corn syrup. Historical prices indicate that corn syrup and no. 11 sugar cane are correlated with a coefficient of .75; and no. 11 raw sugar futures prices per pound have standard deviation of $0.04 while corn syrup prices have a standard deviation per pound of $.03. The contracts size for no. 11 sugar is 112,000 pounds.

1) Given the scenario, how many futures contracts of no. 11 sugar are needed to hedge each 112,000 pounds of corn syrup? Make sure your answer provides for at least two digits to the right of the decimal point.

2) If TastyKake expected to use 225,000 pounds of corn syrup, how many no. 11 sugar futures contracts (round to the nearest integer) should it enter to hedge the price risk as much as possible

Answer 1

I hope my efforts will be fruitful to you.....?