Question

The following questions use the table below about a flour miller that will need wheat soon later this year.

	Now	Later
Cash Wheat Market	$5.00/bu	$5.30/bu
Futures Wheat Market	$4.75/bu	$4.80/bu

1) Is the individual concerned about price increasing or decreasing?

2) What is the initial action in the futures market: buy or sell?

3) What is the cash price paid/received by the individual later?

4) Did the individual earn a profit or loss in this hedging situation? Enter profit or loss in the following blank.

5) What is the value (i.e. amount) of the profit/loss on the hedge for one contract (signs matter)?

6) The basis was initially $0.25 and ended up being _______________.

7) The hedged price in this example was not the current cash price due to the basis changing. What was the hedged price/net purchase price?

8) What was the expected cash price the individual would pay/receive when the hedge was initiated?

9) Due to the use of hedging, was the net purchase/selling price increased or decreased due to the basis changing relative to what would have happened if the individual did not hedge?

Answer 1

1]

the individual is concerned about price increasing because they are a buyer of wheat

2]

Initial action = buy.

This is because the miller wishes to lock in to the purchase price of wheat, and hedge against a price increase

3]

Cash price paid = $5.30/bu

4]

Loss

This is because the increase in futures price was less than the increase in cash price

5]

Profit =  increase in futures price - increase in cash price

Profit =  ($4.80 - $4.75) - ($5.30 - $5.00)

Profit = -$0.25/bu

6]

$0.50 (basis = cash price - futures price = $5.30 - $4.80 = $0.50)

7]

Hedged price = cash price later - profit on futures

Hedged price = $5.30 - ($4.80 - $4.75) = $5.25

8]

$4.75/bu

9]

decreased