Question

In May, Green Grains Inc. placed a long futures positions to hedge against a possible increase in the price of wheat, a key raw material in the production of flour. Based on the selling price that Green Grains earns from its customers, the maximum price that it can pay for wheat is $7.50 per bushel to break even. You also have the following information and assumptions: (1) The current spot price of wheat is $5.63 per bushel, and the September futures price of the commodity is $6.38 per bushel. (2) At $6.38 per bushel, the company will easily break even and make some profit, so it wants to lock in this purchase price for delivery in September. (3) Wheat futures contracts trade in a standard size of 5,000 bushels. To meet its production requirements, Green Grains buys 20 future contracts. In September, the spot price of wheat rose to $9.00 per bushel, and the price of wheat futures rose to $9.60 per bushel. Based on your understanding of the long hedge strategy, the net gain or loss in the future market is ______.

Answer 1

Answer:

The net gain or loss in the future market is $105000

Explanation:

Total Future contracts = 20

Total bushel in 1 contract = 5000

Total quantity of wheat = 20 * 5000 = 100,000 bushel

In Cash Market

Break-even price = $ 7.00

Spot price in September = $ 8.40

Therefore company will make a loss here since spot price is greater than break-even price.

Total Loss = (breakeven - spot price) * Quantity

Total loss = (7 - 8.40) * 100000

= $ - 140,000

In future market

Forward contract price = $ 5.95

Spot price in September = $ 8.40

Here company will make a profit because actual buy price is $ 5.95 and spot price is $ 8.40

Total profit = (Spot price - forward price) * Quantity

= (8.40 - 5.95) * 10000

= $ 245000

Net profit/loss = Profit/Loss in cash maket + Profit/loss in futures market

= $ - 140000 + $ 245000

= $ 105000