Economics 230 Name______
Fall 2010 Section: 1 2
Lab 13 Due: December 6
Risk Management in Crop Production
The purpose of this lab is to explore how forward pricing tools can be used to manage market risks.
Assume that you produced corn on 500 acres with a yield of 160 bushels per acre. Prices seem good for next spring, and you are wondering if you should lock them in for some of your production.
Total number of bushels you expect to market = 80,000 bushels.
Event: Actual price in May
Possible outcomes:
Probability / Cash Price in May / Futures Pricein May / Put Option Premium in May
A. Low price / 25% / $3.50 / $4.00 / $2.05
B. Average price / 50% / $4.50 / $5.00 / $1.10
C. High price / 25% / $5.50 / $6.00 / $ .10
Strategies available:
1. Wait and sell 100% of the crop for the cash price in May.
2. Forward contract 75% of your production for May delivery, sell the rest for the cash price in May.
3. Hedge with futures contracts: sell 75% of the production at the current futures price, then buy the futures contracts back in May at the May futures price, then sell all the crop for the cash price in May.
4. Buy put options: buy options at the current put option premium for 75% of the production, then sell them back at the put option premium in May, then sell all the crop for the May cash price.
Analysis:
Go to the following link: http://www.hoic.com/grain/bids.cfm and find the current forward contract price for any Key Cooperative location for 5/31/11.
$______/ bushel
Go to the following link: http://www.cmegroup.com/ (click on “Agriculture” in the upper left corner, then “Corn) and find the current futures price for a May 2011 corn contract.
Use the “Last” price, and convert it to whole $ and cents per bushel. For example, 551’6 = $5.52.
$______/ bushel
Now find the current premium for a put option, on the same website. Click on the May 2011 Opt button. Find the strike price that is closest to the current futures price, and the “Last” premium for a PUT (not a call) at that price. Convert it to whole $ and cents per bushel. For example, 63’1 = $.63.
Strike price $______/ bushel PUT premium $______/ bushel
Results: Now calculate the expected gross dollars received for each strategy under each outcome. Fill in the white cells, only.
Bushels to sell for cash price in May / 80,000 / 20,000 / 80,000 / 80,000
Cash price in May / $3.50 / $3.50 / $3.50 / $3.50
Total $ from cash sales
Forward contract price for May delivery
Bushels to forward price (75%) / 60,000
Total $ from forward contract sales
Current futures price
Futures price in May / $4.00
Gain/loss on futures (current – May)/bu.
Bushels to hedge (75%) / 60,000
Total gain or loss on futures contract-$
Current put options premium
Put options premium in May / $2.05
Gain or loss on put (May – current)/bu.
Bushels to buy put options for (75%) / 60,000
Total gain or loss on put options-$
Total revenue from cash sales + forward pricing strategy
Average price (total revenue / 80,000 bu.)
B. Average price / Sell 100% cash / Forward contract 75% / Hedge 75% / Buy put options 75%
Bushels to sell for cash price in May / 80,000 / 20,000 / 80,000 / 80,000
Cash price in May / $4.50 / $4.50 / $4.50 / $4.50
Total $ from cash sales
Forward contract price for May delivery
Bushels to forward price (75%) / 60,000
Total $ from forward contract sales
Current futures price
Futures price in May / $5.00
Gain/loss on futures (current – May)/bu.
Bushels to hedge (75%) / 60,000
Total gain or loss on futures contract-$
Current put options premium
Put options premium in May / $1.10
Gain or loss on put (May – current)/bu.
Bushels to buy put options for (75%) / 60,000
Total gain or loss on put options-$
Total revenue from cash sales + forward pricing strategy
Average price (total revenue / 80,000 bu.)
C. High price / Sell 100% cash / Forward contract 75% / Hedge 75% / Buy put options 75%
Bushels to sell for cash price in May / 80,000 / 20,000 / 80,000 / 80,000
Cash price in May / $5.50 / $5.50 / $5.50 / $5.50
Total $ from cash sales
Forward contract price for May delivery
Bushels to forward price (75%) / 60,000
Total $ from forward contract sales
Current futures price
Futures price in May / $6.00
Gain/loss on futures (current – May)/bu.
Bushels to hedge (75%) / 60,000
Total gain or loss on futures contract-$
Current put options premium
Put options premium in May / $.10
Gain or loss on put (May – current)/bu.
Bushels to buy put options for (75%) / 60,000
Total gain or loss on put options-$
Total revenue from cash sales + forward pricing strategy
Average price (total revenue / 80,000 bu.)
Now summarize below the average price received for each strategy under each outcome.
Outcome / Probability / Sell 100% cash / Forward contract 75% / Hedge 75% / Buy put options 75%A. Low price / 25%
B. Average price / 50%
C. High price / 25%
Sell Cash Forward Cont. Hedge Put Options
What is the expected value of each strategy? $______$______$______$______
(sum of each outcome x its probability)
What is the best result for each one? $______$______$______$______
What is the worst result for each one? $______$______$______$______
What is the range of results for each one? $______$______$______$______
(best minus worst)
Summarize the advantages and disadvantages of each strategy.
Sell 100% Cash
Advantages:
Disadvantages:
Forward Contract
Advantages:
Disadvantages:
Hedge
Advantages:
Disadvantages:
Buy Put Options
Advantages:
Disadvantages: