A cotton producer has purchased cotton futures that involve 50,000 pounds of cotton at a price of $0.60 per pound.By contract expiration the producer finds that cotton prices have declined by $0.07 per pound.As a result of the futures contracts,the producer will:
A) lose $3,500 per contract in the futures market which offsets gains in the cash market.
B) gain $3,500 per contract in the futures market which offsets losses in the cash market.
C) lose $3,500 per contract in the futures market and suffer an opportunity cost in the cash market.
D) gain $3,500 per contract in the futures market and gain $0.10 per pound in the cash market.

Question

Quizplus · Accepted Answer

The producer has entered a long position in the futures market by purchasing cotton futures. Since the cotton prices have declined by $0.07 per pound, the producer will incur a loss of $0.07 x 50,000 = $3,500 per contract in the futures market.

However, the producer is still able to sell the physical cotton in the cash market at the current market price which is $0.60 - $0.07 = $0.53 per pound. Therefore, there is no opportunity cost in the cash market.

Overall, the futures market loss of $3,500 per contract does not offset any gains in the cash market. Hence, Choice C is the correct answer.

A Cotton Producer Has Purchased Cotton Futures That Involve 50,000