Kahwa Inc. operates worldwide retail coffee shops. The company expects it will need 1 million pounds of coffee (Grade A) in four months. The standard deviation of the spot price change is 0.25. The company is considering a risk minimization hedge over the four coming months using the 6-month coffee futures contract (coffee Grade B). The contract size is 37,500 pounds. The standard deviation of the futures price change is 0.28. For these particular grades of coffee, the correlation between the futures and spot price changes is 0.93. Today, the spot price of coffee (Grade A) is $1.43 and the 6-month futures price (Grade B) is $1.46 per pound. What is the effective price per pound of coffee for the following scenario?

 

                  At the maturity of the hedge 

                  Basis            Spot Price

Scenario  $0.02            $1.510

 

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