Question

Farmer Brown grows Number 1 red corn and would like to hedge the value of the coming harvest. However, the futures contract is traded on the Number 2 yellow grade of corn. Suppose that yellow corn typically sells for 90% of the price of red corn. If he grows 180,000 bushels, and each futures contract calls for delivery of 5,000 bushels, how many contracts should Farmer Brown buy or sell to hedge his position

Answer 1

40 contracts

Step-by-step explanation:

Calculation to determine how many contracts should Farmer Brown buy or sell to hedge his position

First step is to calculate how much The farmer must sell forward

Farmer must sell forward=180,000∗(1/0.90)

Farmer must sell forward= 200,000bushels of yellow corn.

Now let calculate the requires selling

Requires selling=200,000/ 5,000 bushels

Requires selling =40 contracts.

Therefore how many contracts should Farmer Brown buy or sell to hedge his position is 40 contracts.