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 91% of the price of red corn. If he grows 186,550 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

41 contract

Step-by-step explanation:

The farmer must sell forward:

186,550×(1/0.91)

=186,550×1.09890

= 205,000 bushels of yellow corn.

This requires selling:

205,000/5,000 = 41 contracts

Therefore Farmer Brown should buy or sell to hedge his position 41 contract