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Liquor wholesaler's decision about futures contract

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A liquor wholesaler needs 100,000 gallons of liquor for delivery in London in June 2007. A producer offers to deliver the liquor at that time for $500,000 paid now, in December 2006. The wholesaler can also buy liquor futures contracts for June 2007. 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 June.

(a) The wholesaler considers the futures contract, but worries that the contract will not lock in her cost, because futures prices may fluctuate widely between now and June. 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 liquor futures? (Additional assumptions may be needed to answer. Make sure they are reasonable.) Explain briefly.

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The Solution provides a short response with explanation on the concept of futures contracts.

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(a) No, he needs liquor 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 need ...

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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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