Question

In: Finance

We are in mid-October 2020. You have just been put in charge, until July 2021, of...

We are in mid-October 2020. You have just been put in charge, until July 2021, of revenue risk management for

a soybean oil producer that processes about 500,000 bushels of soybeans a month (soybeans = input, soybean oil

and meal = main outputs). The policy of your predecessor in this job has always been to buy beans on the cash

(i.e., spot) market.

a. (2.5 points) Before leaving, your predecessor entered into a commodity swap agreement (i.e., a bundle of

forward contracts) to sell the company’s entire output (mostly soya oil and meal) to General Mills. This

commodity swap is set to run monthly for the next two years. Which of the following events would leave your

company strictly better off during your tenure as its risk manager?

(i) Over the course of the next 9 months (till you leave), the spot price of beans goes down but the spot

prices of the refined products (oil and meal) goes down even faster.

(ii) Over the course of the next 9 months, the spot price of beans stays level while the spot prices of the

refined products goes up.

(iii) The price of beans goes up – who cares what happens to the price of the products.

(iv) None of the above.

Explain briefly.

Expert Solution

My predecessor has entered into a forward contract to sell the Company's entire Output (Soya Oil & Meal ) to General Mills for the next two years.

This means that the price at which the Output will be sold to General Mills has already been decided by the Company.

As such in Option (i) the Company will be better off. In Option (i) the spot price of the Raw Material goes down , thus the Raw Material Cost of the Company will be reduced.

In Option (i) the price of the Output (Soya Oil & Meal ) goes down even faster , but this will not impact the company as the company has already entered into a forward contract to sell the entire Output which means the selling price has already been decided upon.

Thus Event (i) will be better for the company.

jeff jeffy answered 2 years ago

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