Question: A cereal maker requires rye in three months and is concerned that prices of rye will rise in the interim. Currently the spot rate of

A cereal maker requires rye in three months and is concerned that prices of rye will rise in the interim. Currently the spot rate of rye is 25 cents per ounce and 3-month rye futures price is 37 cents. The cereal maker is considering buying rye now and store for 3 months or alternatively buy 3-month rye futures. The cereal maker can store and insure rye at a cost of 5 cents per ounce per month. Payment for this cost is due at the beginning of each month. Interest rate is 10% continuously compounded.

A) Calculate (i) storage cost, (ii) accrued interest, and (iii) total carrying cost per ounce.

B) What is the theoretical price of a three-month futures contract?

C) Which alternative (buying rye now or buying a futures contract) should the cereal maker choose? Explain why.

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