A long hedge is a risk management strategy in which a company can lock in the price
Question:
A long hedgeis a risk management strategy in which a company can lock in the price of the commodity that can be purchased in the future.Consider the case of Blue Grains Inc., a flour manufacturer: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 $7.05 per bushel to break even. You also have the following information and assumptions:
| The current spot price of wheat is $5.29 per bushel, and the September futures price of the commodity is $5.99 per bushel. | |
| At $5.99 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 $8.46 per bushel, and the price of wheat futures rose to $9.02 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:
$247,000
-$599,000
-$141,000
$902,000
Cash Market
Net gain or loss in the cash market:
-$141,000
$846,000
-$705,000
$303,000
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.
Expert Answer:
To calculate the net gain or loss in the futures market we need to determine the difference between ... View the full answer
