Disher Cotton Farms is a large cotton producer located near Lubbock, Texas. Each year Disher plants its fields in cotton and then waits until the fall before the cotton is picked and sold. Disher knows that its cost of producing cotton is about $0.45 per pound. In April when the cotton is planted, the current market price for cotton is $0.53. The October futures price is $0.51. Disher expects to produce 250,000 pounds of cotton this season.
a. If Disher does not hedge its cotton crop, what total revenue can it expect to receive in October?
*Color blocks behind the numbers denote problems that have check answers provided at the end of the book.
CHALLENGE
b. If Disher does hedge its cotton crop in the futures market, what total revenue can it expect to receive in October? What type of hedge is this called?
c. Which alternative (a or b) is preferred and why?
d. What risks does Disher face if it sells its entire expected cotton crop in the futures market?