A milling company buys a futures contract that requires it to take delivery of 5,000 bushels of wheat at a price of $6.80 per bushel.At expiration the spot price of wheat is $6.68 per bushel.The miller:
A) has saved $0.12 per bushel through hedging.
B) has locked in an effective price of $6.80 per bushel.
C) can choose not to take delivery since the price declined.
D) has locked in an effective price of $6.68 per bushel.

Question

Quizplus · Accepted Answer

By buying the futures contract, the milling company has locked in a price of $6.80 per bushel, regardless of the spot price at expiration. Therefore, they have effectively hedged against any potential price increases. Even though the spot price at expiration was lower at $6.68 per bushel, the milling company is still obligated to take delivery at $6.80 per bushel. However, this may still be a beneficial choice for the milling company if the spot price had increased above $6.80 per bushel.

A Milling Company Buys a Futures Contract That Requires It