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It's May 2020. You are a wheat grower, planning to sell 100,000 bushels of wheat to AgriCorp. in May 2021 in exchange for a spot price prevailing at that time. Because May 2021 spot price is unknown today, your objective is to hedge this risk. Suppose that the only available contract is for June 2021 delivery. Today the futures price of wheat for June 2021 delivery is $7.40 per bushel. Contract size for wheat futures is 5,000 bushels. Assume that there is no excessive volatility during delivery month. Problem (a) If you were to hedge using futures market, would you enter short or long futures position in May 2020 and in how many contracts? Explain.
In parts (b) and (c) assume that in May 2021 the futures contract's price turns out to be $6.20 a bushel and spot price turns out to be $6.15 a bushel. Problem (b) Calculate total profit or loss on your futures position Problem (c) What is the overall price per bushel realized by the oil distributor in May 2021 after taking into account hedging profits or losses? Show your calculations.
In part (d) assume that in May 2021 the futures contract's price instead turns out to be $9.80 a bushel and spot price turns out to be $9.90 a bushel. Problem (d) What is the overall price per bushel realized by the oil distributor in May 2021 after taking into account hedging profits or losses? Show your calculations. (e) Given your answer in parts c and d, did hedging reduce volatility of the realized price?
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