Knowing you have taken finance courses, your neighbor Sean, who is a wheat farmer in Edmonton, is asking for your help. He is expecting to sell wheat in 9 months and is worried that wheat price may fall, which will definitely reduce the profit. You learned from him that the current price for wheat is $9.4 per bushel and interest rates are at 4%. In addition, the storage cost of wheat is $0.2 per bushel, paid today. 

(a) Should Sean long or short forward contract to hedge the price risk of wheat? Explain it clearly.

(b) What is the 9-month forward price of wheat? 

(c) Sean told you the wheat price in 9 month may take the following values ($9, $9.1, $9.2, $9.3, $9.4, $9.5, $9.6 $9.7, $9.8). Prove to Sean that he could effectively sell wheat at the forward price you computed in regardless of the wheat price realized in 9 months.

Answer rating: 100% (QA)

a Sean should long a forward contract to hedge the price risk of wheat By entering into a long forwa... View the full answer