Six months from now, Farmer Don will harvest 10,000 bushels of corn. In doing so

Question

Six months from now, Farmer Don will harvest 10,000 bushels of corn. In doing so, he incurs costs of $32,000. The current spot price of corn is $3.50 per bushel, and the effective six-month interest rate is 5 percent. Don has decided to hedge with a collar by purchasing $3.30-strike puts and selling $3.70-strike calls on 10,000 bushels of corn. The puts have a premium of $0.16 per bushel, while the calls have a premium of $0.31 per bushel. What total profit would Don earn if the market price of corn at harvest time is $2.90, $3.30, $3.70, and $4.10, respectively?

Explanation / Answer

Cost of purchasing put(Long) $0.16 Amount received for call(Short) $0.31 Net Amount received per bushel $0.15 (0.31-0.16) Six months effective interest rate=5%=                 0.05 Future Value of $0.15 after 6 months $0.1575 (0.15*(1+0.05) Future Value of total net premium received $1,575 (10000*0.16) Cost of harvesting 10000 bushel after 6 months $32,000 P A B C=A+B D=C*10000 E F G=P*10000 H=D+E+F+G Market Price at harvest time Payoff per bushel for long put (strike$3.30) Payoff per bushel for Short call (Strike $3.70) Net Payoff per Bushel after six months Net Pay off for 10000 bushel Value of net premium received Total Cost of haevesting Amount received for selling corn Total Profit Earned $2.90 $0.40 $0 $0.40 $4,000.00 $1,575 ($32,000) $29,000 $2,575.00 $3.30 $0 $0 $0.00 $0.00 $1,575 ($32,000) $33,000 $2,575.00 $3.70 $0 $0 $0.00 $0.00 $1,575 ($32,000) $37,000 $6,575.00 $4.10 $0 ($0.40) ($0.40) ($4,000.00) $1,575 ($32,000) $41,000 $6,575.00 Market Price at harvest time Total Profit $2.90 $2,575.00 $3.30 $2,575.00 $3.70 $6,575.00 $4.10 $6,575.00

Related Questions

Navigate

• Browse (All)
• Browse S
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.