Your company buys wheat to make bread. How can you hedge your exposure to the price...

Your company buys wheat to make bread. How can you hedge your exposure to the price of wheat? Check all that apply: Buy call options on wheat

1.Buy wheat futures

2.Buy put options on wheat

3.Sell call options on wheat

4.Sell wheat futures

Solutions

Expert Solution

Only one of the 5 options given in question can be used for hedging your exposure to the price of the raw material of bread i.e. is wheat. You can Buy wheat futures. As your company makes bread so the requirement of wheat will always will be there, so there is no need to buy option derivatives. You need to fix a price for the raw material which can be done by buying wheat futures.

Buying wheat futures will eliminate the exposure of risk of price fluctuations. You will have an effective price on which you bought the futures contract.

Example:

Today in spot market, Price of wheat = $200/metric ton. And you require wheat stock every 3 months. But you don't know what will be the price of wheat after 3 months. A 3 months futures contract is available at $205/metric ton. You can buy this futures contract and fix your price today for 3 months from now. At expiry, whatever be the price in spot market you will effectively buy wheat at $205/metric ton. Assume that the price after 3 months will be $210/metric ton, then you will get a net benefit on future contract of $5/metric ton and now you can but wheat from spot market at $210/metric ton, and your effective price will be $205/metric ton.

So in this way to can completely hedge your exposure towards the price of wheat.

jeff jeffy answered 6 months ago

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