Suppose you have £1000 in your bank account. The price of wheat is currently £100 per barrel. Due to unfavourable weather conditions you believe that supply will fall in the near future, however because demand is highly inelastic you also believe that the price will rise, so you decide to buy 10 barrels of wheat with your £1000 today. You decide to sell these 10 barrels after three months when the price has risen to £140 per barrel.

(i) Calculate your profit net of an overall storage cost of £50.

Now imagine instead of buying the actual barrels of wheat you purchased call options which gave you the right to buy a barrel of wheat at £100 pounds in three months. Suppose you spend all of your £1000 on call options which cost £10 each and the price of wheat per barrel is £140 in three months time.

(ii) Calculate your overall profit net of the cost of the call

Answer rating: 100% (QA)

i Initial investment 1000 Price per barrel of wheat 100 Number of barrels purchased ... View the full answer