Hedging Help

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  • #189356
    samfutureCPAboy
    Participant

    I need help with this… I understand when the price decreases, but I don’t understand when the price increases. How can the rancher lose $10 per pound when by buying a future contract for $150 and selling it for $160. Isn’t that a gain? I am so confuse.

    A March futures contract is purchases for a price of $150

    • For simplicity, assume the rancher antipates (and does sell) selling

    50,000 pounds (1 contract)

    • Spot prices are currently $155

    • What happens when the spot price is March decreases to $140?

    – Rancher loses $10 per 100 pounds on the sale from the decreased price

    – Rancher gains $10 by selling the futures contract for $150 and immediately buying (to close out) for $140

    – Effective price of the sale is $150

    • What happens when the spot price is March increases to $160?

    – Rancher gains $10 per 100 pounds on the sale from the increased price

    – Rancher loses $10 by buying the futures contract for $150 and immediately selling (to close out) for $160

    – Effective price of the sale is $150

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  • #613307
    ScarletKnightCPA
    Participant

    Okay, can we get the answer for each question? My understanding is that buyer of the futures contract would be the one buying the underlying asset. I think that the question is saying that the rancher is selling the contract thus will be selling the underlying asset. So if he sells the futures contract at 150 per unit but the actual price turns out to be 160 he is losing 10dollars per unit when sale day comes.

    Do you understand?

    It looks like this question was by design made to be tricky.

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    #613308
    samfutureCPAboy
    Participant

    @ scarlet – Thanks for the reply. I think I'm kind of getting your explanation. Basically, he sold a contract for 150,000 when he could have sold it for 160,000, right? The answer is already there. It's below the questions.

    CA Candidate

    F- 68, 78 (Thank you, Lord)
    A- 75 (Thank you, Lord God)
    R- 72, 75 (Thank you, Lord God Almighty)
    B- 74, 77 (Thank you, Lord God Almighty Forever!) DONE!!

    Education - Completed
    Ethics Exam - 100%
    Experience - In Progress

    “Faith is believing that God is going to take you places before you even get there.” - Matthew Barnett

    #613309
    ScarletKnightCPA
    Participant

    Yes exactly.

    What makes this question tricky is that they start buy stating the purchase price and then they start talking about the seller.

    When it comes to futures and forwards contracts, at least academically wise, when you are selling the contract, you are selling the underlying asset. When you are buying the contract, you are buying the underlying asset.

    Options are different, you can buy a call option or sell a call option, buy a put or sell a put.

    Far: 76 (Wiley Test Bank)
    Aud: 77 (Wiley Test Bank)
    Reg: 61, 76 (Wiley book, Wiley Test Bank)
    Bec: 86 (Wiley Test Bank)

    MBA in progress

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