A manufacturer of breakfast cereal is concerned about corn prices. The firm anticipates needing 1 million bushels of corn in one month. The current price of corn is $6.60 per bushel and the futures price for delivery in one month is $7.25 per bushel. The cost to store the corn for 1 month is $150 000. What should the firm do?

Question

Quizplus · Accepted Answer

If the firm buys the corn now and stores it for 1 month, the total cost will be:

1,000,000 bushels x $6.60/bushel = $6,600,000 for the corn
$150,000 for storage = $6,750,000

If the firm hedges with futures, the total cost will be:

1,000,000 bushels x $7.25/bushel = $7,250,000 for the corn
No storage cost since the firm is not taking physical delivery
Total cost = $7,250,000

Therefore, buying the corn now and storing it for 1 month is the cheaper option.

A Manufacturer of Breakfast Cereal Is Concerned About Corn Prices