Question

1. On October 1, an elevator who holds soybeans, fears its price decrease due to reports of big crop in Brazil. He did the following calculation and trades in both the cash and futures markets on October 1 and May 10. Please fill in blanks in the table. Assume there is no basis risk and the basis did not change in the whole process. Date Cash Futures May Futures $6.40 1-Oct Cost of Production $6.00 Expected Basis -$0.301 (A) What is the forward price? = (B) What is the expected profit margin? = 1-Oct Sell May Futures @ $6.40 Buy May Futures @ ? 10-May Sell Cash @ $5.70 (C) What is futures price on May 10th? = (D) What is the gain or loss on futures market result? = (E) What is the gain or loss on cash market result? = (F) What is the realized price (or net selling price)? (G) What is the overall profit? = 2. Long Hedge: A cattle producer bought the input from the market. The basis equaled -S.40, and did not change in the process. Date Cash Futures 1-Feb Estimated Purchased Costs $3.00 Oct Futures Contract $3.25 (A) What is the forward price? = (B) What is the expected profit margin? = 1-Feb Buy Oct Futures @ Sell May Futures @ $3.25 $3.65 10-Oct Buy Cash @ ? (C) What is cash price on Oct 10th? = (D) What is the gain or loss on futures market result? = (E) What is the gain or loss on cash market result? (F) What is the realized price (or net buying price)? = (G) What is the overall profit? =

Answer 1

1. (A)

If interest rates are certain then futures and forward prices are equal. And basis is the difference between spot and futures price. So, on 1st October, the cost of production can be considered as spot price.

Spot price= $6

Basis = -$0.30

Basis = spot price - future price

-$0.30=$6-future price

Future price= $6+$0.30 =$6.30

Since there is no basis risk, we can say future and forward price are same. Hence, forward price is $6.30

(C) The future and spot price coincide with each other at the time of expiry of the contract.