Farmer John is a wheat farmer who plans on selling his wheat in the future. Farm

Question

Farmer John is a wheat farmer who plans on selling his wheat in the future. Farmer John anticipates he
will have 60,000 bushels of wheat to sell next September. However, he is concerned that the future
market price of wheat will be low, which would result in low revenues from the sale of his wheat. The
local farm bureau forecasts three possible prices for wheat next September: 325 cents, 335 cents or 345
cents. Suppose the futures price is 341 cents and that each futures contract is for 5,000 bushels of wheat.
(a) If Farmer John wanted to guarantee himself a certain sales price should he take a long or short
position in the future contract?
(b) How many contracts should he trade to employ a strategy to guarantee himself a certain sales price?
(c) Show using the following table that if Farmer John employs the hedge strategy from Parts (a) and (b)
then he is guaranteed a certain revenue next September no matter what happens to the wheat price. What
is the amount of this certain revenue? SHOW YOUR WORK.

Farmer John is a wheat farmer who plans on selling his wheat in the future. Farmer John anticipates he will have 60,000 bushels of wheat to sell next September. However, he is concerned that the future market price of wheat will be low, which would result in low revenues from the sale of his wheat. The local farm bureau forecasts three possible prices for wheat next September: 325 cents, 335 cents or 345 cents. Suppose the futures price is 341 cents and that each futures contract is for 5,000 bushels of wheat. (a) If Farmer John wanted to guarantee himself a certain sales price should he take a long or short position in the future contract? (b) How many contracts should he trade to employ a strategy to guarantee himself a certain sales price? (c) Show using the following table that if Farmer John employs the hedge strategy from Parts (a) and (b) then he is guaranteed a certain revenue next September no matter what happens to the wheat price. What is the amount of this certain revenue? SHOW YOUR WORK.

Explanation / Answer

a) If Jhon wants to sell his wheet in future, he need to be enter in short contract. That is selling wheet in a future date and the specific price is 341 cents per one bushel.

b) Each contract is 5000 bushels, and the total expected production is 60000 bushels. So the number of contracts would be 12 (60,000/5,000)

c)

325 cents 335 cents 345 cents revenue from wheet 3900 4020 4140 profit from futures position 192 72 (48) total revenue 4092 4092 4092

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