Assume you are a wheat producer in eastern Colorado. You have 3200 acres (or 5 sections) in production and your potential yield (based on a trend-yield projection) is 37.5 bushels per acre. Production costs are $150 per acre.

It is currently December 1, 2019. You are considering hedging some of the wheat crop which you will market at harvest in early-July or which you will store until early-October. If you store the grain, you will only do so until October because you will need the cash flow to meet a production operating note payment. We will use the basis information that is similar to what was constructed from Problem Set 1.

You have made a small basis table and include the basis information for the relevant months. Averages and standard deviations are reported below.

A. It is December 1, 2019 and the current KC wheat futures prices are

12/1 DEC $5.55/bu.

MAR20 $5.63/bu.

MAY $5.50/bu.

JUL $5.45/bu.

SEP $5.63/bu.

DEC $5.75/bu.

(The futures prices above are presented just like they are on exchange websites and in the WSJ. If you cannot read them and the dates correctly throughout the problem set then you will receive zero credit. In other words, you have to know what contracts are priced for and when.) Evaluate the profit opportunity for hedging until harvest. You will need to pick the best contract for the production hedge from the nearby and next-to-nearby contracts. Ignore any difference between actual bushels and hedged bushels unless you are specifically asked. Label the two different futures contracts.

Production Hedge:_________ Contract

Forward Price $ _______/bu.

Production Costs $ ________/bu.

Profit $_____________ /bu.

Risk $ _____________/bu.

Production Hedge:________ Contract

Forward Price $ ____________/bu.

Production Costs $__________ /bu.

Profit $ _______________/bu.

Risk $ ________________/bu.

Which contract will you use for the production hedge?________________ .

Show some of the necessary calculations here:

Production costs per bushel =

Forward price for production hedge using__________________ contract =

Forward price for production hedge using ___________________ contract =

B. Lets evaluate some probabilities of different outcomes to support the decision making. Use the NORM.DIST function and write the arguments used in the function in the space below the question. The following statistics are based on the 13 years of data history from Problem Set 1.

The average price of wheat in Colorado was $5.45/bu. with a standard deviation of $1.53/bu.

What is the probability that the market price will be below the breakeven?

What is the probability that the market price will be below the forward price?

The average harvest price was $5.50/bu. with a standard deviation of $1.42/bu.

What is the probability that the harvest price will be below the breakeven?

What is the probability that the harvest price will be below the forward price?

The above two expectations are not very thoughtful. We have better information.

Last years harvest price was $4.27/bu. The average harvest price change was +$0.12 with a standard deviation of $1.45/bu. (Careful, read and think.)

What is the probability that the harvest price will be below the breakeven? % What is the probability that the harvest price will be below the forward price?

Potential Futures Contracts Calendar Month MAR MAY JUL SEP DEC Harvest Transaction Month July. -0.59 (0.48) -0.69 (0.53) Storage Transaction Month October -1.00 (0.51) -1.03 (0.53) -0.87 (0.49) Potential Futures Contracts Calendar Month MAR MAY JUL SEP DEC Harvest Transaction Month July. -0.59 (0.48) -0.69 (0.53) Storage Transaction Month October -1.00 (0.51) -1.03 (0.53) -0.87 (0.49)