How much of the variance can be eliminated by cross hedging

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Reference no: EM132021907

The table shows 57 historical days of closing prices for wheat futures, corn futures, and sorghum. All prices are dollars per bushel, as indicated.


		Wheat futures	Corn futures	Sorghum spot
	Historical	price	price	price
	Day	$/bushel	$/bushel	$/bushel
	1	$5.00	$3.95	$3.60
	2	$5.05	$3.92	$3.57
	3	$5.18	$3.97	$3.62
	4	$5.07	$3.93	$3.58
	5	$4.85	$3.88	$3.53
	6	$4.72	$3.82	$3.47
	7	$4.70	$3.85	$3.50
	8	$4.59	$3.83	$3.48
	9	$4.74	$3.84	$3.49
	10	$4.96	$3.91	$3.56
	11	$4.89	$3.92	$3.57
	12	$5.01	$3.96	$3.61
	13	$4.95	$3.93	$3.58
	14	$5.05	$3.99	$3.64
	15	$5.08	$3.98	$3.63
	16	$4.91	$3.90	$3.55
	17	$4.83	$3.89	$3.54
	18	$4.86	$3.85	$3.50
	19	$4.69	$3.79	$3.44
	20	$4.67	$3.85	$3.50
	21	$4.66	$3.90	$3.55
	22	$4.58	$3.88	$3.58
	23	$4.63	$3.84	$3.54
	24	$4.72	$3.89	$3.59
	25	$4.90	$3.96	$3.66
	26	$4.85	$3.96	$3.66
	27	$4.95	$4.07	$3.77
	28	$5.19	$4.17	$3.87
	29	$5.32	$4.17	$3.87
	30	$5.67	$4.47	$4.17
	31	$5.50	$4.47	$4.17
	32	$5.49	$4.52	$4.22
	33	$5.50	$4.50	$4.20
	34	$5.43	$4.48	$4.18
	35	$5.82	$4.49	$4.19
	36	$5.80	$4.54	$4.24
	37	$5.74	$4.60	$4.30
	38	$5.70	$4.67	$4.37
	39	$5.64	$4.54	$4.24
	40	$5.62	$4.55	$4.25
	41	$5.56	$4.56	$4.26
	42	$5.50	$4.46	$4.16
	43	$5.30	$4.31	$4.01
	44	$5.22	$4.33	$3.98
	45	$5.18	$4.29	$3.94
	46	$5.22	$4.29	$3.94
	47	$5.13	$4.18	$3.83
	48	$5.05	$3.99	$3.64
	49	$5.11	$4.01	$3.66
	50	$5.02	$3.93	$3.58
	51	$4.99	$3.99	$3.64
	52	$4.99	$3.96	$3.61
	53	$4.96	$3.92	$3.57
	54	$4.92	$3.94	$3.59
	55	$4.97	$3.98	$3.63
	56	$4.97	$3.96	$3.56
	57	$5.02	$3.99	$3.59

Question : Southern Plains is a farming cooperative that is located in Kansas. Southern Plains would like to hedge its 450,000 bushel inventory of sorghum. Sorghum is a type of cereal grain that is used to feed livestock and to create biofuels. Since there are no futures contracts on sorghum, Southern Plains would like to cross hedge using either corn futures or wheat futures. The size of 1 corn futures is 5,000 bushels, which is also the size of 1 wheat futures. The historical data for this question can be found in a spreadsheet that is in the homework folder on ANGEL. Which futures contract, wheat or corn, offers the better hedge? If Southern Plains chooses the better hedge, how much of the variance can be eliminated by cross hedging? How many contracts should it trade? Long or short?

Reference no: EM132021907

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