Evaluating Hedging With Futures Contracts A large farming company likes to firm up prices for its agricultural products. It anticipates harvesting and selling 1,000,000 bushels of a particular commodity in six months. Constant news reports and changes in forecasts cause fluctuations in the spot price for the commodity. The current spot price is $5.00 per bushel. Futures contracts are available at $4.75 per bushel and six-month put option contracts with an exercise price of $5.00 per bushel are available for $0.35. A noninterest-bearing margin deposit of $200,000 is required if futures contracts covering the entire 1,000,000 bushels are sold. The company's current cost of money is 4 percent per annum.
Required
a. Explain the advantages and disadvantages of hedging the harvest's value with futures contracts.
b. Calculate the spot price six months hence at which the company is indifferent between not hedging and hedging with futures contracts.
c. Assume the spot price stands at $5.25 per bushel when 1,000,000 bushels of the commodity are harvested (not sold) and that commodity inventories are carried at market. Explain, using calculations as needed, how the company's financial statements will differ without hedging compared to hedging with futures contracts.