Question

Economics of Hedging with Futures

Great Lakes Distributors buys 100,000 bushels of soybean futures at $9.95 per bushel, to cover a commitment to deliver 100,000 bushels of soybeans to a customer in 60 days at a price of $10.25 per bushel. No margin deposit is required. Spot and futures prices for soybeans are equal and fluctuate between $9.50 and $10.40 per bushel. On the day of delivery to the customer, Great Lakes closes its futures position and buys soybeans in the spot market to fulfill its agreement with the customer.

Required

a. Calculate the cost per bushel to Great Lakes if the spot price at the time of purchase is $9.50.

$Answer per bushel

Calculate the cost per bushel if the spot price is $10.40.

$Answer per bushel

b. Prepare the entries Great Lakes makes to record the above events if the spot price is $10.20 per bushel on the day the futures contract is closed, Great Lakes buys the soybeans on the spot market, and delivers them to the customer. The futures position qualifies as a fair value hedge of the firm commitment to sell soybeans to the customer. Great Lakes records income effects of these transactions in cost of goods sold.

Description		Debit	Credit
AnswerCashCommodities inventoryCost of goods soldFirm commitmentSales revenue		Answer	Answer
AnswerCashCommodities inventoryCost of goods soldFirm commitmentSales revenue		Answer	Answer
To close the futures position.
AnswerCashCommodities inventoryCost of goods soldFirm commitmentSales revenue		Answer	Answer
AnswerCashCommodities inventoryCost of goods soldFirm commitmentSales revenue		Answer	Answer
To record the higher cost of fulfilling the obligation to the customer.
AnswerCashCommodities inventoryCost of goods soldFirm commitmentSales revenue		Answer	Answer
AnswerCashCommodities inventoryCost of goods soldFirm commitmentSales revenue		Answer	Answer
To record purchase of the soybeans.
AnswerCashCommodities inventoryCost of goods soldFirm commitmentSales revenue		Answer	Answer
AnswerCashCommodities inventoryCost of goods soldFirm commitmentSales revenue		Answer	Answer
To record sales revenue.
AnswerCashCommodities inventoryCost of goods soldFirm commitmentSales revenue		Answer	Answer
AnswerCashCommodities inventoryCost of goods soldFirm commitmentSales revenue		Answer	Answer
To record purchase of the commodities.
AnswerCashCommodities inventoryCost of goods soldFirm commitmentSales revenue		Answer	Answer
AnswerCashCommodities inventoryCost of goods soldFirm commitmentSales revenue		Answer	Answer
To categorize the hedge gain as a reduction of cost of goods sold.

Please answer all parts of the question.

Answer 1

(a)

Calculation of Net Cost per Bushel					Calculation of Gain/(Loss) on Futures
Spot Price at purchase	9.5	10.4			Sale Price (Spot Price)	9.5	10.4
-Gain/(Loss) by sale of futures	-0.45	0.45			-Buying Price	9.95	9.95
Net Cost per Bushel	$9.95	$9.95			Gain/(loss)	$-0.45	$0.45

(b)

Sr. No.	Description	Debit ($)	Credit ($)
1	Payable for Futures Dr	995000
	Cash Dr	25000
	To Futures Receivable		995000
	To Hedge Gain		25000
	(To close the futures position)
2	Cost of Goods sold Dr	25000
	To Inventory		25000
	(To record the higher cost of fulfilling the obligation to the customer.)
3	Inventory Dr	1020000
	To cash		1020000
	(To record purchase of the soybeans.)
4	Accounts Receivable Dr	1025000
	To Sales		1025000
	Cost of goods sold Dr	995000
	To Inventory		995000
	(To record sales revenue.)
5	Futures Receivable Dr	995000
	To Payable for Futures		995000
	(To record purchase of the commodities.)
6	Hedge Gain Dr	25000
	To Cost of Goods sold		25000
	(To categorize the hedge gain as a reduction of cost of goods sold.)