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A drink wholesaler needs 100,000 gallons of cheap cognac for delivery in New York in June 2017. A producer offers to deliver the cognac at that time $500,000 paid now, in May 2016. The wholesaler can also buy cheap cognac futures contracts for November 2016. The current futures price is $51,000 for each 10,000 gallon futures contract. The wholesaler is determined to lock in the cost of the 100,000 gallons needed in November.

(a) The wholesaler considers the futures contract, but worries that the contract will not lock in his cost, because futures prices may fluctuate widely between now and November. Is his concern justified? Why or why not?

(b) Do you recommend that the wholesaler pay the producer now or take a long position in cognac futures?

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Solution Summary

The expert examines forwards and future questions on contracts. How the prices may fluctuate are determined.

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(a) No, the wholesaler needs cognac in 6-months and by following either approach he will be laying off this risk to the market. The interim price fluctuations are irrelevant.

(b) In order to answer this, we ...

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Umut Oltulu, MBA
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  • BSc, Dokuz Eylul University
  • MBA, Texas A&M University-Kingsville
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