Question

In six months, a cereal company plans to sell 20,000 boxes of “Corn Crisps” for $4.00 per box and will need to buy 10,000 bushels of corn to do so. In doing so, it also incurs non-corn costs of $33,000. The current spot price of corn is $4.30 per bushel, and the effective six-month interest rate is 4 percent. The company will hedge by purchasing call options at $0.57 with a strike price of $4.20 per bushel. What total profit would the company earn if the market price of corn in six months is $3.70, $4.10, $4.50, and $4.90, respectively?

Answer 1

Soln : Non corn cost , N = $33000, Selling value of corn crisps, S = 20000*4 = $80000

Price for buying call options = 0.57*10000 = $5700

If market price of corn per Bushel, M = $3.70, option will not be exercised

Cost of bushel = 3.70*10000 = 37000

Total profit = 80000 -5700-37000-33000 = $4300

If M = 4.10, option will not be exercised

Net profit = 80000 - 5700-33000 - 41000 = $300

If M = 4.50, option will be exercised and corn be bought at $4.2

Net profit/loss = 80000-5700-33000-42000 = -$700

Same will be the value in case if M = 4.90, as option is exercised.