9. Hedging strategy to protect against rising prices

A long hedge is a risk management strategy in which a company can lock in the price of the commodity that can be purchased in the future.

In May, Blue Grains Inc. placed a long futures position to hedge against a possible increase in the price of wheat, a key raw material in the production of flour. Based on the selling price that Blue Grains earns from its customers, the maximum price that it can pay for wheat is $7.40 per bushel to break even. You also have the following information and assumptions:

	The current spot price of wheat is $5.55 per bushel, and the September futures price of the commodity is $6.29 per bushel.
	At $6.29 per bushel, the company will easily break even and make some profit, so it wants to lock in this purchase price for delivery in September.
	Wheat futures contracts trade in a standard size of 5,000 bushels. To meet its production requirements, Blue Grains buys 20 future contracts.
	In September, the spot price of wheat rose to $8.88 per bushel, and the price of wheat futures rose to $9.47 per bushel.

Based on your understanding of the long hedge strategy, complete the transactions in the futures and cash markets:

Futures Market

Net gain or loss in the futures market:

$947,000

$259,000

$629,000

-$148,000

Cash Market

Net gain or loss in the cash market:

$740,000

-$148,000

$888,000

$318,000

Thus, the gain and loss offset each other, and the company benefits from placing the long hedge. The company earns a net profit of and helps protect the producer to purchase a commodity against rising prices.