Assignment:
You are a farmer in south-central Pennsylvania producing wheat for the cash grain market. You have planted 100 acres of winter wheat in the fall of 2016 and you are wondering whether you should hedge your output. You expect a yield of at least 50 bushels per acre. Below is a table listing the range of the wheat basis in your area based on recent history.
|
South-central PA Wheat basis (cents per bushel)
|
|
Month
|
Average
|
|
JAN
|
43
|
|
FEB
|
41
|
|
MAR
|
40
|
|
APR
|
39
|
|
MAY
|
36
|
|
JUN
|
22
|
|
JUL
|
16
|
|
AUG
|
19
|
|
SEP
|
25
|
|
OCT
|
30
|
|
NOV
|
34
|
|
DEC
|
39
|
|
YEAR
|
32
|
You plan to sell your wheat in July 2017. The July 2017 futures price in Chicago as you prepare to plant the wheat is $5.00.
1. What is the price you would expect in your local area if the futures price is an accurate forecast of the Chicago price for when you plan to sell your wheat? What is your expected total revenue? Please show and explain your work.
2. If you want to use the futures market to hedge what would you do? Explain in detail what you would do and when.
3. It is now July 152017. The price of the July contract in Chicago is $5.50. The price offered by your local flour mill is $5.70. Your actual production is 5,500 bushels. You are ready to harvest and sell your wheat. Please explain exactly what you will do? Assuming a commission of 1 cent per bushel calculate how your hedge worked out? Please explain the result and show your work.
4. How does your total revenue with the hedge compare to what you would have received if you had not hedged your expected production? Explain what accounts for the difference.