Assume its December and a feeder cattle producer has agreed to provide 240,000 pounds of feeder cattle
Question:
Assume it’s December and a feeder cattle producer has agreed to provide 240,000 pounds of feeder cattle at the current market price in 3 month’s time (late March). Currently, the market price is $1.25/lb and the producer feels a good profit can be attained at that price given their management style.
However, the producer knows they can manage price risk by hedging feeder cattle contracts against a possible cash market decline. Assume the producer wants 100% price coverage. Currently available feeder cattle futures contracts and prices (prices are in dollars/lb):
January $1.30
March $1.32
April $1.35
May $1.37
Question 1. Which contract month and price would you select from the above list to begin the hedge? ___________________
In late March, prior to delivery, feeder cattle prices fell 10% to $1.13/lb on the local cash market and since we are nearing delivery the futures price for an __________ contract has also nearly converged to the cash market levels with a price of $1.17/lb.
Question 2. Which month fills in the blank of the above sentence?
Question 3. For this livestock producer, the hedge is considered a short hedge (True or False).
Question 4. Assuming the producer closes the hedge and adds any gains/losses from the futures market, what is the final price received for the producer?
Date Cash Futures Basis
December $1.25/lb 1.35/lb (Long or Short? $-0.10
Late March $1.13/lb 1.17/lb (Long or Short? $-0.04
Net Price Received? __________________
Sales Proceeds
Planned: 240,000 Lbs * Planned Price in December ($1.25) = $300,000
With Hedging: 240,000 Lbs * Net Price at the end of the Hedge ($________ ) = $________
Without Hedging: 240,000 Lbs * Late March Cash Price ($1.13) = $271,200
Be prepared to answer at least one or two more questions from this analysis.
Fundamentals of Financial Management
ISBN: 978-0324597707
12th edition
Authors: Eugene F. Brigham, Joel F. Houston