Cereal Delites uses corn as the primary ingredient in their cereal. As a result, the ﬁrm has a down sloping risk proﬁle which shows that it will suffer a ﬁnancial loss if the price of corn rises. To offset
This risk, the ﬁrm should _____ a forward contract on corn with a payoff proﬁle that is _____.

Question

Quizplus · Accepted Answer

To offset the risk of a loss due to rising corn prices, the firm should buy a forward contract on corn with an up-sloping payoff profile. This means that as the price of corn rises, the payoff from the contract will also increase, helping to offset the financial loss from the increased cost of the corn used in their cereal. Choice A is incorrect because selling a forward contract would increase the firm's risk exposure to rising corn prices. Choices C and D are incorrect because a horizontal payoff profile would not provide any protection against price movements. Choice E is incorrect because selling a forward contract with an up-sloping payoff profile would increase the firm's risk exposure to rising corn prices.

Cereal Delites Uses Corn as the Primary Ingredient in Their