Question

Farmer Brown grows Number 1 red corn and would like to hedge the value of the coming harvest. However, the futures contract is traded on the Number 2 yellow grade of corn. Suppose that yellow corn typically sells for 95% of the price of red corn. If he grows 156,750 bushels, and each futures contract calls for delivery of 5,000 bushels, how many contracts should Farmer Brown buy or sell to hedge his position?

Answer 1

Answer:

Sell 33 contracts

Explanation:

According to the scenario, computation of the given data are as follows:

Price of yellow corn = 95% of red corn

Bushels grows = 156,750

So, yellow corn bushels = 156,750 × (1 ÷ 95%)

= 165,000

So, number of contracts sell = 165,000 ÷ 5,000

= 33 contracts.

Hence, the farmer Brown should sell 33 contracts to hedge his position.