John is a farmer. In three months, his harvest will be ready and he will sell a big contract of 500,000 pounds of wheat. The spot market price of wheat is now $0.50 per pound but it is likely to increase. However, John is risk averse and to protect himself against the uncertainty related to the harvest, he decides to use futures contracts as hedge. The futures contracts are worth 500,000 pounds of wheat and have a current price of $0.55 per pound and expiration date in three months. Show the cash flows of the futures contracts, of the underlying transaction and of the hedge strategy if the price of wheat at delivery date is $0.30 per pound, $0.50 per pound and $0.70 per pound.

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ANSWER To understand the cash flows of the futures contracts the underlying transaction and the hedg... View the full answer