You, a farmer, anticipate taking 80,000 bushels of soybeans to the market in three months. The current cash price for soybeans is $5.85. The size of the futures contract is 5,000 bushels per contract, and the current three-month futures price is $5.88. You decide to hedge one-half of your exposure to a drop in the value of soybeans. Assume that in three months, when you take the soybeans to market, you close out the futures contracts and the price has fallen to $5.80. What is the total loss in value over the three months on the actual soybeans you produced and took to market?

Question

Quizplus · Accepted Answer

The farmer anticipates taking 80,000 / 2 = 40,000 bushels to market, since he is hedging half of his exposure.

Since the farmer is hedging with futures, he locks in a price of $5.88 per bushel for 40,000 / 5,000 = 8 contracts.

If the price falls to $5.80 in three months, then the loss on the actual soybeans is ($5.85 - $5.80) x 40,000 = $2,000.

The futures contracts are closed out at $5.80 per bushel, resulting in a gain of ($5.88 - $5.80) x 40,000 = $320.

Therefore, the total loss in value over the three months is $2,000 - $320 = $1,680.

Since the question asks for the total loss in value over the three months on the actual soybeans, the answer is $2,000 (choice D).

You, a Farmer, Anticipate Taking 80,000 Bushels of Soybeans to the Market