The hedge would be to sell wheat forward on the futures exchange at $3.41 per bushel.
Additionally, the wheat farmer is worried about prices going down, not up. If he knew prices would continue higher, he would do nothing and reap a great financial harvest from his crop, selling at high prices. Since he cannot possibly "know" what future price will be, he is worried price will go down and wants to hedge his risk. To do that, he would sell futures and lock in today's price. If price goes down, he makes money on the futures, but loses money on his crop; thus the hedged position is price neutral.
If the farmer wants to hedge his entire crop of 60,000 bushels, he would sell 12 contracts.
At exercise of the futures contract, he will deliver his 60,000 bushels of wheat at the agreed price of $3.41, for a gross revenue of $198,600.
"Include in your calculations the loss of interest on the $150,000 that the
farmer had to draw from his savings account to purchase seeds and equipment."
c) Since he is hedged perfectly, any loss/gain in the futures is perfectly offset by the wheat crop; exactly delta neutral. There is no loss or gain at any price (except for expenses).
Since he would be selling wheat, his hedge is to buy.
b) you can do that part
c) Figure that loss of interest in b and add it to the futures contract value.
d) incomplete
...
A Wheat farmer expects to harvest 60,000 bushels of wheat in September. In order to pay for
the seed and equipment, the farmer had to draw $150,000 from his savings account on
January 1 this year. He earns 4.8% p. a. on the savings account, and interest on the account
is compounded monthly. The farmer is worried about fluctuations in the wheat price and
wishes to hedge the position. Wheat futures are currently quoted as $3.41 per bushel. Wheat
futures contracts are 5,000 bushels per contract [i.e., if you buy one wheat futures contract at
a price of F per bushel, you are contracting to purchase 5,000 bushels of wheat on the
futures expiration date at a cost of (5000 x F) dollars.]
(a) Should the farmer buy or sell futures to hedge himself against changes in the price of
wheat? How many contracts should he buy/sell?
(b) What is the net profit the farmer will make on his harvest, assuming he carries out the
futures transaction from part (a), and his harvest yields exactly 60,000 bushels in
September? Include in your calculations the loss of interest on the $150,000 that the
farmer had to draw from his savings account to purchase seeds and equipment. Assume
that the Futures transaction takes place on the last day of September, and that his costs
for transporting the harvested wheat to the counterparty in the futures transaction are
negligable.
(c) At what futures price would the farmer exactly break even on the transaction?
(d) Suppose that December whe
