5. Central Mills (CM) is a snack food manufacturer. The company's fruit snack manufacturing plant, located...

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5. Central Mills (CM) is a snack food manufacturer. The company's fruit snack manufacturing plant, located in St. Paul, Minnesota, uses approximately 225,000 pounds of sugar every three months. The company has enough storage at the facility for three months of sugar, so it purchases sugar from its local supplier every three months. The company just purchased three months of sugar that is now in storage, but the company's risk manager, Josh Allen, is concerned that the price of sugar may increase between now and the next time the company will have to purchase sugar (in three months). Today sugar in the spot market is trading at $0.1749 per pound. Three-month out sugar futures are trading at $0.1801. Traditionally, the basis when CM will remove their hedge in three months has been -$0.0020 per pound. One sugar contract contains or represents 112,000 pounds of sugar (50 long tons). Prices in the futures contract are quoted in dollars and cents (out to four decimals) per pound of sugar. (a) If Josh decides to hedge the company's future sugar purchase with futures, what position should he take in the futures market? Why? (b) When CM management asks Josh what price they might expect to pay for the sugar they will have to purchase in three months if they choose to follow Josh's guidance, what should Josh tell them? That is what is the company's "expected hedge price?" Three months later, when the manufacturing plant is ready to resupply its sugar storage, sugar trades in the spot market at $0.1625 per pound. Nearby futures (consistent with the futures contract used by CM in their hedging activity) are trading at $0.1650 per pound. (c) What was CM's "realized hedge price?" (d) What is the realized hedge price equal to the expected hedge price? If not, why (be specific, using terms we've discussed in class)? What caused the difference? (e) When CM's CEO reviews the company's financials for the quarter, he is upset and asks for a meeting with Josh Allen (the company's risk manager). Why is the CEO upset, and what should Josh say? 5. Central Mills (CM) is a snack food manufacturer. The company's fruit snack manufacturing plant, located in St. Paul, Minnesota, uses approximately 225,000 pounds of sugar every three months. The company has enough storage at the facility for three months of sugar, so it purchases sugar from its local supplier every three months. The company just purchased three months of sugar that is now in storage, but the company's risk manager, Josh Allen, is concerned that the price of sugar may increase between now and the next time the company will have to purchase sugar (in three months). Today sugar in the spot market is trading at $0.1749 per pound. Three-month out sugar futures are trading at $0.1801. Traditionally, the basis when CM will remove their hedge in three months has been -$0.0020 per pound. One sugar contract contains or represents 112,000 pounds of sugar (50 long tons). Prices in the futures contract are quoted in dollars and cents (out to four decimals) per pound of sugar. (a) If Josh decides to hedge the company's future sugar purchase with futures, what position should he take in the futures market? Why? (b) When CM management asks Josh what price they might expect to pay for the sugar they will have to purchase in three months if they choose to follow Josh's guidance, what should Josh tell them? That is what is the company's "expected hedge price?" Three months later, when the manufacturing plant is ready to resupply its sugar storage, sugar trades in the spot market at $0.1625 per pound. Nearby futures (consistent with the futures contract used by CM in their hedging activity) are trading at $0.1650 per pound. (c) What was CM's "realized hedge price?" (d) What is the realized hedge price equal to the expected hedge price? If not, why (be specific, using terms we've discussed in class)? What caused the difference? (e) When CM's CEO reviews the company's financials for the quarter, he is upset and asks for a meeting with Josh Allen (the company's risk manager). Why is the CEO upset, and what should Josh say?

Answer rating: 100% (QA)

a To hedge the companys future sugar purchase using futures Josh should take a long position in the futures market This means that he should buy sugar ... View the full answer