Question

You have a farm in Alberta and you expect to have 1,000 tonnes of canola for sale in the fall. You would like to hedge your risk of price fluctuations through the Winnipeg Commodity Exchange. Today is early March, and the cash price for canola is C$590 per tonne. The settle price on a futures contract to sell your canola in November is C$576 per tonne. Assume you enter into a futures contract to deliver 1,000 tonnes of canola.

a. Assume the price of canola in the cash market, in Alberta, in November is C$615 per tonne. Without delivering your canola to Winnipeg, close out the futures contract and calculate your gains, losses, and net receipts on the 1,000 tonnes of canola. (Negative answers should be indicated by a minus sign. Omit $ sign in your response.)

	1000 tonnes
(Click to select)  Gains  Losses	$
Net receipts	$

b. Assume the price of canola in the cash market, in Alberta, in November is C$540 per tonne. Without delivering your canola to Winnipeg, close out the futures contract and calculate your gains, losses, and net receipts on the 1,000 tonnes of canola. (Negative answers should be indicated by a minus sign. Omit $ sign in your response.)

	1000 tonnes
(Click to select)  Gains  Losses	$
Net receipts	$

Please provide Correct answers. thanks.

Answer 1

In this sum, we are expecting to have 1,000 tonnes of canola for sale in the fall. We are hedging our risk by entering into futures contract to sell those 1,000 tonnes in November at C$576 per tonne. (Here the spot price is not much of use as we don't have canola to sell today)

While entering into the contract there is no actual cash flow but cash flow will happen when we square off the position or deliver.

a. Scenario 1

Spot Price of canola is C$615 per tonne in November

Here we will have two things to do

1. Close out future contract

2. Sell canola in spot market

Now to close out the position in futures we will have to take opposite position in the futures market thus we will have to buy the contract at $615 per tonne. (As we are selling at lower price and buying at higher price we mill make a loss in futures contract)

thus here will make a loss of (590-615) = -C$25 per tonne thus for 1000 tonne loss would be -$25 * 1000 = -C$25,000

Sell Canola in spot market at $615 per tonne thus getting C$615 * 1000 = C$615,000 for canola

Total Cashflow = -25000 + 615000 = C$590,000

Loss in Futures Contract

Net Receipts C$590,000

b. Scenario 2

Spot Price of canola is C$540 per tonne in November

Here we will have two things to do

1. Close out future contract

2. Sell canola in spot market

Now to close out the position in futures we will have to take opposite position in the futures market thus we will have to buy the contract at $540 per tonne. (As we are selling at higher price and buying at lower price we mill make a profit in futures contract)

thus here will make a profit of (590-540) = C$50 per tonne thus for 1000 tonne profit would be $50 * 1000 = C$50,000

Sell Canola in spot market at $540 per tonne thus getting C$540 * 1000 = C$540,000 for canola

Total Cashflow = C$50,000 + C$540,000 = C$590,000

Profit in Futures Contract

Net Receipts C$590,000

This sum is good example how we hedge our risk with futures contract, as we have entered into futures contract, our net receipts will always be equal irrespective of the market condition.