Question
Part 1 You are a farmer in south-central Pennsylvania producing wheat for the cash grain market. You have planted 100 acres of winter wheat in
Part 1 You are a farmer in south-central Pennsylvania producing wheat for the cash grain market. You have planted 100 acres of winter wheat in the fall of 2017 and are wondering whether you should hedge your output. You expect a yield of at least 50 bushels per acre. Below is a table listing the range of the wheat basis in your area based on recent history. South-central PA Wheat basis (cents per bushel) Month Average JAN 43 FEB 41 MAR 40 APR 39 MAY 36 JUN 22 JUL 16 AUG 19 SEP 25 OCT 30 NOV 34 DEC 39 YEAR 32 You hope to sell your wheat in July 2018. The July 2018 futures price at the Chicago Board of Trade as you prepare to plant your wheat is $5.00. 1. What is the price you would expect in your local area if the futures price is an accurate forecast of the Chicago price for when you plan to sell your wheat? What is your expected total revenue? Please show and explain your work.
2. If you want to use the futures market to hedge what would you do? Explain exactly what you would do and when.
3. It is now July 22 2018. The price of the July contract in Chicago is $5.50. The price offered by your local flour mill is $5.70. Your actual production is 5,500 bushels. You are ready to harvest and sell your wheat. Please explain exactly what you should do? Assuming a commission of 1 cent per bushel calculate how your hedge worked out? Please explain the result and show your work.
4. How does your total revenue with the hedge compare to what you would have received if you had not hedged your expected production? Explain what accounts for the difference. Part 2 You are a producer of potatoes. You have to decide whether to sell your crop now or store it and sell later. You have just harvested your crop and the current market price is $28 per cwt. You have enough storage capacity for your entire crop and your storage cost per cwt. is defined by: SC$ = 0.35 + .1T2 where T = 1,..N the number of months in storage, T = 1...11. You can only keep your potatoes in storage until the new crop is harvested. The sales price for potatoes changes through time according to a premium over the price at harvest time given in the following table. You will note that this premium starts to decline at some point, because of the deterioration in the average quality of stored potatoes.
1. Calculate the market price and the storage cost in each month and put these in the table. Calculate the net sales price for each month.
2. Which is the most profitable month for you to sell the stored potatoes? Explain.
3. Which is the last month in which you make a positive return from storing potatoes? Explain.
4. If you were offered a contract by a supermarket to deliver a fixed quantity of potatoes per month at a price of $33 per cwt., when does it become unprofitable to supply potatoes under that contract? Explain
Time Market Price Premium ($) Market price ($) Storage cost ($)Net sales price ($) Harvest (Month 0) 0 28 0 28 Month 1 1 Month 2 2 Month 3 3 Month 4 4 Month 5 5 Month 6 6 Month 7 7 Month 8 7 Month 9 5 Month 10 3 Month 11 1
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