Question

The following questions use the table below on soybean oil. Answer the following questions about an end user needing to purchase soybean oil. One soybean oil contract is 60,000 pounds (lbs).

	Now	Later
Cash Soybean Meal Market	$0.335/lb	$0.346/lb
Futures Soybean Meal Market	$0.3000/lb	$0.311/lb

1) Is the individual concerned about price increasing or decreasing?

2) What is the initial action in the futures market: buy or sell?

3) What is the cash price paid/received by the individual later?

4) Did the individual earn a profit or loss in this hedging situation? Enter profit or loss in the following blank.

5) What is the value (i.e. amount) of the profit/loss on the hedge for one contract (signs matter)?

6) What is the hedged price per bushel on this transaction?

7) If the individual didn't hedge, what would have been the price paid/received for the cash commodity?

8) The individual made the right decision to hedge: Yes or No.

9) What is the net selling (or purchase) price?

Answer 1

PART 1-

The individual is concerned about price increasing because if the future prices rise, he will have to pay more amont for purchasing same quantity of soyabean oil.

PART 2-

Initial action in the future market is BUY. In this way, he can protect himself from further increase in the prices of Soyabean oil.

PART 3-

Since he has to BUY Soyabean oil, cash paid in future market will be calculated as ( cash soyabean meal price later * contract size ) i.e. 60,000 pounds * $0.346 =$20,760

PART 4 -

If he has hedged his position, then he would have entered into the contract at $ 0.311 / lb whereas the cash price later went up to $ 0.346 / lb. Thus, in one unit he saved $0.035 ( $0.346 - $0.311)

Total proit = Lot size * saving per unit = 60,000 pounds * $ 0.035 = $2,100

PART 5-

Value (i.e. amount) of the profit/loss on the hedge for one contract = +$0.035

If he has hedged his position, then he would have entered into the contract at $ 0.311 / lb whereas the cash price later went up to $ 0.346 / lb. Thus, in one unit he saved $0.035 ( $0.346 - $0.311)

PART 6-

Hedged price per bushel on this transaction = $0.311 / LB

PART 7-

If the individual didn't hedge, the price paid for the cash commodity = cash price in spot market later = $0.346 / LB

PART 8 -

Yes, The individual made the right decision to hedge, since the spot prices went up after hedging.

PART 9-

net purchase price = lot size * future price today = 60,000 pound * $0.311 / lb = $18,660

Incase of any doubt, please comment below. I would be happy to help.

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