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Risk Management and Hedging Using Futures

You have been hired as a Financial Analyst at "Burger Donalds" and scheduled to begin on September 1, 2012. Your first Assignment involves the Futures Markets. The Burger Production Manager informs that he wants 5 million bushels of wheat on December 31, 2012 of the year to ensure continued and uninterrupted production of Super Burgers. You glance through the Wall Street Journal on September 1 and observe these prices. [Think Cost of Carry Models]

Spot Price of Wheat on Sept 1 (Per Bushel) $7.52
October Wheat futures price (Delivery on Oct 31) $7.56
November Wheat futures price (Delivery on Nov 30) $7.58
December Wheat futures price (Delivery on December 31) $7.60

From Historical company records you know that if you buy the wheat ahead of the required time you can store it at a cost of 2 cents per bushel per month. Outline all your strategies (at least five!) and their implications.

Solution Preview

Below is your study guide.

In risk management, specifically the use of hedging instruments such as commodity futures, the risk manager has to have the following information:
1. Requirements for the commodity in the covered period. In Burger Donaldsâ?? you need to know how many bushels of wheat you need. This information was given â?? 5 million bushels on December 31, 2012.
2. Cost of storage which is also provided.
3. Expectations on the spot price on the date the commodity is actually needed. This is important since this will drive the strategy you would eventually adopt. For example, if you expect that ...

Solution Summary

Risk management and hedging using futures are examined for a financial analyst. The spot price of wheat is determined.

$2.19