Question

A food company is planning to purchase 5,000,000 pounds of beef in six months. The company is concerned about changes in the price of beef. Your assignment is to construct a futures contract hedge to protect the company’s cost. The current wholesale price of beef is 106 Cents per pound.

The livestock futures contracts are for 40,000 pounds. The futures contract quoted price is Cents per pound. The coefficient of correlation between livestock and beef is 0.93. The standard deviation of livestock and beef are 56.35 and 68.25 respectively.

The available futures contracts are This information was downloaded from CME Group website:

Month	Last (cents)	Change	Prior Settle	Open	High	Low
Aug-18	106.075	-0.3	106.375	106.85	107.325	105.775
Oct-18	108.65	-0.975	109.625	109.9	110.275	108.3
Dec-18	112.825	-0.875	113.7	113.775	114.05	112.4
Feb-19	116.325	-0.2	116.525	116.5	116.775	115.35
Apr-19	117.825	-0.425	118.25	118.45	118.45	117.125
Jun-19	110.65	-0.5	111.15	111.175	111.175	110
Aug-19	109.675	-0.325	110	109.7	110	108.95
Oct-19	111	-0.6	111.6	111	111	111

Part a. Describe the Repo rate.

Part b. Describe the Fed Funds rate

Answer 1

Optimal Hedge Ratio = Std. Dev. of Bief*correlation/Std. Dev. of Live Stock

= 68.25*0.93/56.35

= 1.1264

No of Contracts required = (Bief Required*Optimal Hedge Ratio)/No of Contracts

= (5000000*1.1264/400000)

= 14.08 Contracts

To Hedge the Future volitility of the prices we have to take the 14.08 Live Stock.

Describe the Repo rate.

Repo rate is the rate at which the central bank of a country (Federal Bank In USA) lends money to commercial banks in the event of any shortfall of funds. Repo rate is used by monetary authorities to control inflation.

Describe the Fed Funds rate

The federal funds rate refers to the interest rate that banks charge other banks for lending to them excess cash from their reserve balances on an overnight basis. By law, banks must maintain a reserve equal to a certain percentage of their deposits in an account at a Federal Reserve bank. Any money in their reserve that exceeds the required level is available for lending to other banks that might have a shortfall.