A cereal farmer has a stock of wheat of 50 tonnes, and plans to sell them in a year.

1) A cereal farmer has a stock of wheat of 50 tonnes, and plans to sell them in a year. The spot price is € 100 / t, the 1-year interest rate is 1%, the cost of storing wheat is 0.5% of the value of the inventory, payable at maturity. What do you advise him to do if he wants to hedge against fluctuations in the price of wheat, and the one-year wheat price is € 100.5 / t? What is the “fair” price of wheat at one year?

2) A miller plans to buy 100 tonnes of wheat in a year. The spot price is € 100 / t, the 1-year interest rate is 1%, the cost of storing wheat is 0.5% of the value of the inventory, payable at maturity. What do you advise him to do if he wants to hedge against fluctuations in the price of wheat, and the one-year wheat price is € 102.5 / t? What is the “fair” price of wheat at one year?

Expert Solution

1. Fair Forword price = Spot price*e^rt + Storage cost

= 100*e^(.01)+100*0.5%

= 101.505

As fair forword price is 101.505 Greater than current one-year wheat price is € 100.5 / t. It is advised for him to not hedge the position by selling the one year price.

2. As fair forword price is 101.505 Less than current one-year wheat price is € 102.5 /t. It is advised for him to not hedge the position by buying the one year price.

He can rather buy the wheat now and store it. It will cost him less in such a way.

jeff jeffy answered 2 years ago

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