Use the following table of futures market data dated June 27, 2017 to answer que
ID: 2792382 • Letter: U
Question
Use the following table of futures market data dated June 27, 2017 to answer questions 1 and 2 below: OPEN HIGH LOW SETTLE CHG Cocoa-10 Metric tons; dollars per metric ton July 2017 1975 1987 1880 1827 +8 Sep 20171840 1899 1840 1859 +14 Dec 2017 1867 1920 1864 1883 +13 Soybean Oil-60,000 pounds; cents per pound Dec 2017 32.0132.73 32.00 32.53 +0.54 Jan 2018 32.18 32.88 32.18 32.66 +0.52 Mar 2018 32.37 33.01 32.37 32.78+0.49 I. Suppose you work for Hershey's and bought 200 contracts of December 2017 cocoa futures contract on August 31, 2017 at the settle price of the day a) Are you hedging or speculating? b) What will your total profit or loss be if cocoa prices are $1900 per metric ton at expiration? c) What will your total profit or loss be if cocoa prices are $1800 per metric ton at expiration? 2. McDonald's hedges its cooker oil purchases with soybean oil futures contracts and is projecting its oi purchases for March 2018. It has estimated a total demand of 2,400,000 pounds. The company is using its usual strategy of hedging its costs. a) What position (number of contracts & long or short) should the company take to cover the entire demand, and what price are they effectively locking in? (Use the settle price of the day) b) Suppose soybean oil prices are 40.50 cents per pound in March. What is the profit or loss on the futures position? c) Explain how the futures position has eliminated McDonald's exposure to price risk.Explanation / Answer
1a) This is an example of hedging. Since Hershey’s is a chocolate manufacturing company Cocoa is used as a raw Material. Hershey’s will be prone to the risk of increase in the price of Coca and thus to hedge itself against the price risk Hershey is buying futures contract on Cocoa.
1b) Purchase Price of Dec 17 Contract: $ 1883
Profit/Loss: (Price at Expiration-Purchase Price)×No of Contract × Contract Multiplier
= (1900-1883)×200×10
=$ 34,000 (Profit)
1c) Purchase Price of Dec 17 Contract: $ 1883
Profit/Loss: (Price at Expiration-Purchase Price) × No of Contract × Contract Multiplier
= (1800-1883) × 200 ×10
=$ -166,000 (Loss)
2a) Again for McDonald’s cooker oil is a raw material input. Therefore, it needs to buy futures contract to hedge its risk from price increase.
No of long contracts required: Total Demand / (Contract Multiplier)
=2,400,000 /(60,000)
=40 contracts.
By buying the futures contract Mcdonalds is effectively locking in a price of $ 32.78.
2b) Profit/Loss: (Price at Expiration-Purchase Price) × No of Contract × Contract Multiplier
= (40.50-32.78) × 40 ×60,000
=$ 18,528,000 (Profit)
2c) By buying the futures contract Mcdonald’s has locked in a price a of $ 32.78. If price rises above $ 32.78 then any loss that Mcdonald’s would be making is offset by the gain in the futures position. Similarly if prices fall below $ 32.78 then any gain that Mcdonald’s would be making is offset by the loss in the futures contract.
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