Question

If a farmer sells his corn forward on the harvest date, what risks have increased, and...

If a farmer sells his corn forward on the harvest date, what risks have increased, and what risks have decreased, compared to not selling forward?

Use monthly data to compute the volatility and correlation between the NASDAQ and S&P returns over the last 1 year, over the last 2 years, and over the last 5 years. Show your results on a graph.

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Answer #1

When a farmer sells his corn forward, the price that the farmer will realise by selling his corn is fixed today. The price risk is therefore hedged. However, as the price is fixed, the farmer is saved if the price decreases in future as the price was already fixed and the farmer will lose out some profits if the price increases in future.

Thus, the risk of price increase increases

and the risk of price decrease decreases

There are some other associated risks regarding quality, time of delivery etc which will arise if the farmer is not able to deliver the type of quality and the time at which is agreed in the contract.

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