Reference no: EM132182287

Question - Mr. Gott A. Praublum produces wheat on some leased ground. He doesn't have any grain storage on his place, however. This means at harvest he will have to sell all of his wheat or use commercial storage. He plants his wheat in the fall, and discusses the possibility of hedging his wheat with his banker. Mr. Lender agrees that given Mr. Paublum's current financial situation, he cannot withstand a big market risk on his crop. Mr. Paublum expects to harvest his wheat at the end of July and pay off a note at the bank with the sale of his crop. He planted a total of 1000 acres and his past production records indicate an average yield of 30 bushels per acre. On December 1, Mr. Praublum has his broker, Fingers Meppelli, place the hedge. Finger informs Mr. Praublum he got in the market for $5.76/bu for the entire expected harvest. According to historical data the basis is usually $0.40/bu under at the end of July. At harvest Mr. Praublum sells his wheat at the local elevator for $5.00/bu and lifts the hedge for $5.25/bu.

a) Is this an example of a short hedge or a long hedge?

b) What is the expected target price when the hedge is placed?

c) Show the transactions in the cash and futures market (use same format as presented in class).

d) What is the realized price after the hedge is lifted?

e) What was the basis when the hedge was lifted?

f) Did basis narrow (strengthen) or widen (weaken) compared to expectations?