According to Encik Mohd Haris Mohd Arshad, the Sime Darby Oils Managing Director, the year 2021 could be an even more volatile year for the palm oil industry. The palm oil industry experts forecast that the CPO prices to range between RM3.320 to RM4.113 per ton in the spot market, while that of the third-month palm oil futures contract on Bursa Malaysia will be traded between RM3.000 to RM4.000 per ton.

In April 2021, the July FCPO contract was at RM84 higher than the CPO price per ton in the spot market. Encik Jeman anticipates harvesting 610 metric tons of CPO ready for sale in the second week of July 2021. He is worried that the price of CPO may fall between now and the next three months and is considering using futures contracts as his hedging tool. He understands that this technique may allow him to lock his future transaction at the current higher price.

Required:

i) One of the biggest disadvantages of using futures contract is the inability to tailor any futures contract to perfectly fit the unique circumstances of the hedger. Explain how this limitation concerning the quantity and delivery date of the CPO may affect Encik Jeman's hedging strategy.

ii) Advise Encik Jeman on the best strategy to hedge against this price risk and show the impact of the proposed action on his future cash transaction. Assume that the current market price of CPO is RM3,810 per ton. The prices of CPO and FCPO converged at RM3.682 per ton upon maturity of the futures contract. Support your answer with relevant calculations.

Answer rating: 100% (QA)

i The limitation regarding the quantity and delivery date of the CPO in futures contracts can affect Encik Jemans hedging strategy in several ways Qua... View the full answer