Q2. Hedging Strategy Q2.1 Suppose you are a processor who will purchase 20,000 bushels of wheat in May 2023 from the local market. You value each bushel of wheat at $10, i.e., you can sell it to a downstream food company for $10 per bushel. Denote the May 2023 price of wheat at the local market as PlocalMay, what is your local-market payoff as a function of PlocalMay Draw a graph showing this relation, where the x-axis is PlocalMay and the y-axis is your local-market payoff. Q2.2 You are worried that wheat price will increase between now and May 2023 and you plan to use the futures market to mitigate the risk. What kind of hedging strategy shall you use? Please specify long/short positions at the local and futures markets. Also specify which contracts you need to trade and how many contracts you need to trade. (Wheat futures has a 5,000 bushels contract size). Q2.3 You are ready to trade in the futures market. The May 2023 wheat futures is now trading at $7 per bushel. Based on your hedging strategy from Q2.2, what is your futuresmarket payoff as a function of May 2023 futures price Pfutures?SimilartoQ2.1,drawaMay graph of this function. Q2.4 What is your overall payoff as a function of PlocalMay and PfuturesMay ? Under what condition you are guaranteed to receive a fixed amount of profit? How much profit you can receive for each bushel of wheat? Q2.5 Suppose the condition in Q2.4 is satisfied. Draw a graph that contains the following: (1) payoff from the local market, (2) payoff from the futures market, and (3) overall payoff. Q2.6 Now suppose you are considering using options to hedge. What type of options (put or call) will you buy? Suppose this option has a strike price of $10 and is currently raded for a $1 premium. Draw a graph to show the local market payoff, options payoff, and he overall payoff. Q2. Hedging Strategy Q2.1 Suppose you are a processor who will purchase 20,000 bushels of wheat in May 2023 from the local market. You value each bushel of wheat at $10, i.e., you can sell it to a downstream food company for $10 per bushel. Denote the May 2023 price of wheat at the local market as PlocalMay, what is your local-market payoff as a function of PlocalMay Draw a graph showing this relation, where the x-axis is PlocalMay and the y-axis is your local-market payoff. Q2.2 You are worried that wheat price will increase between now and May 2023 and you plan to use the futures market to mitigate the risk. What kind of hedging strategy shall you use? Please specify long/short positions at the local and futures markets. Also specify which contracts you need to trade and how many contracts you need to trade. (Wheat futures has a 5,000 bushels contract size). Q2.3 You are ready to trade in the futures market. The May 2023 wheat futures is now trading at $7 per bushel. Based on your hedging strategy from Q2.2, what is your futuresmarket payoff as a function of May 2023 futures price Pfutures?SimilartoQ2.1,drawaMay graph of this function. Q2.4 What is your overall payoff as a function of PlocalMay and PfuturesMay ? Under what condition you are guaranteed to receive a fixed amount of profit? How much profit you can receive for each bushel of wheat? Q2.5 Suppose the condition in Q2.4 is satisfied. Draw a graph that contains the following: (1) payoff from the local market, (2) payoff from the futures market, and (3) overall payoff. Q2.6 Now suppose you are considering using options to hedge. What type of options (put or call) will you buy? Suppose this option has a strike price of $10 and is currently raded for a $1 premium. Draw a graph to show the local market payoff, options payoff, and he overall payoff
