Given a 25% chance of a 600,000 bushel yield and a 75% chance of a 500,000 bushel yield,what quantity should the farmer hedge in order to protect against an uncertain harvest? Assume the farmer is willing to take reasonable risk.
A) 0
B) 500,000
C) 525,000
D) 600,000

Question

Quizplus · Accepted Answer

In order to protect against the uncertain harvest, the farmer should hedge the most likely yield, which is 500,000 bushels. However, since the farmer is willing to take reasonable risk, hedging for a slightly higher yield would provide additional protection. Therefore, hedging 525,000 bushels would be the best choice. Hedging for 600,000 bushels would be too high of a risk, as the chance of that yield is only 25%. Hedging for 0 bushels would also not provide any protection.

Given a 25% Chance of a 600,000 Bushel Yield and a 75