As a producer of wine in the Niagara region, you have the opportunity to either lease vineyards from local grape-growers or to purchase grapes from other farmers. In the past you have purchased grapes from the Okanagan Valley in British Columbia, and from the Sonoma Valley in California.
The quality of wine depends in part on the quality of grapes input to the fermenting process, but your fermenting machinery has a fixed capacity. Any unused capacity in one year cannot be applied to a different use. To obtain the best return, your preference is to operate at practical capacity even if projected demand or normal capacity is higher. An interesting opportunity in the industry is the ability to enter into a contract in the spring to pay a specific dollar value for grapes harvested in the fall.
Financial experts call this a hedging contract because you are protecting yourself against the risk that actual prices in the fall (the spot price) will be higher than your spring contracted price (the strike price). The quantity and quality of grapes harvested each year depend largely on a single uncontrollable factor—the weather. In spring you must decide on the input mix of harvested and purchased grapes that you believe is most likely to make the best use of available practical capacity—but you have no idea what the weather will be in the months before harvest.
A supplier approaches you in the spring with a proposition to sell you grapes and specifies the strike price. This supplier from the Okanagan provides you with a historical trend chart that summarizes the association between weather and yield from the vineyard for the last eight years.
REQUIRED
1. Explain your reasons for your contracting decision.
2. Of what use would similar information on your own market share be?