Question

It’s September 2015 and United Grain Growers (UGG) wants to hedge the planned sale of 80,000 metric tons of corn in March 2016. Corn is a non-Board grain, and UGG recently acquired this inventory and is storing it in two new concrete high throughput elevators.

Corn futures contracts are available, and to avoid the contracts’ delivery requirements, UGG will hedge using April 2016 corn futures, where one contract is for 5000 bushels. The initial margin requirements are 1650 per contract, spot price for corn today is 3.70 per bushel, while the futures prices for the April contract is 4.25 per bushel. Note: 5000 bushels ≈ 127 metric tons.

1. How many contracts are needed for this hedge? Long or short?
2. What is the total margin requirement?
3. In March 2016, UGG sold corn to the market at the then spot price of 4.00 per bushel. On the sale date they closed the futures contracts (“offset” them), and the futures price was 4.15/bushel at that time. What is the net per bushel price obtained for corn, reflecting the hedge g/l?

Answer 1

Ans a:
80000	metric tonnes
5000	bushels	1 contract
127	metric tonnes	1 contract
for 80000 metric tonnes no of contracts = 80000/127
	629.92	contracts
thus we need 630 contracts to hedge for this situation
UGG should short 630 April 2016 Future Contracts to hedge their position
Ans b: Margin Requirement per contract = 1650, thus for 630 contracts it should be =630*1650 = 1039500
Ans c:
In September 2015 UGG had 80000 MT or 3149606 Bushels
This was bought at Spot Price @ 3.70 per Bushel
So UGG paid in September 2015 = 3149606*3.70 = 11653542
In March 2016 UGG sold 80000 MT or 3149606 Bushels
This was Sold at Spot Price @ 4.00 per Bushel
So UGG received in March 2016 = 3149606 * 4.0 = 12598424
(i) Net Per Bushel price made in Spot Market = 12598424-11653542 = 944882
In September 2015 UGG has shorted (Sold) 630 contracts in Future Market @ 4.25 per Bushel
In March 2016 at offsetting date 630 contracts in Future Market can be Bought @ 4.15 per Bushel
This offsetting transaction in future market will lead to a Net Gain of 0.10 per Bushel i.e. Selling High Buying Low (difference = 4.25-4.15 =0.10)
(ii) 630 contracts = 630*5000 = 3150000 Bushels
So gain per contract = 0.1 thus for 630 contracts or 3150000 Bushels = 3150000*0.1 = 315000
(iii) Total Net per Bushel price obtained for Corn reflecting hedge gain = 944882 + 315000 = 1259882