It is now February 16. The managers of a firm which produces cattle feed is committed to purchasing 100,000 bushels of soybeans on September 1 in order to meet certain existing supply contracts. The firm’s managers want to use the November soybean futures contracts to hedge its price risk because they do not want to be forced to take physical delivery under the contract. Each contract is for the delivery of 5,000 bushels of soybeans. The standard deviation of monthly changes in the spot price (in cents per bushel) of soybeans is 1.4. The standard deviation of monthly changes in the November futures price of soybeans is 1.3. The correlation between the futures price changes and the spot price changes is 0.92.
a. To hedge the price risk, should the feed producer take a short or long position in the futures contract?
b. What is the minimum variance hedge ratio implied by the data provided?
c. Suppose that the November futures price on the day on which the hedge is put in place is $10.01 per bushel while the spot price is $9.86 per bushel. If on September 1 the November futures price is $10.17 per bushel and the spot price is $10.12 per bushel, what effective net price per bushel which the feed producer will pay for the soybeans?