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ps7_Futures - Economics 172 Intermediate Finance Spring...

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Economics 172 Intermediate Finance Spring 2011 Problem Set 7: FUTURES 1 1. A Wheat farmer expects to harvest 60,000 bushels of wheat in September. In order to pay for the seed and equipment, the farmer had to draw $150,000 from his savings account on January 1 this year. He earns 4.8% p. a. on the savings account, and interest on the account is compounded monthly . The farmer is worried about fluctuations in the wheat price and wishes to hedge the position. Wheat futures are currently quoted as $3.41 per bushel. Wheat futures contracts are 5,000 bushels per contract [i.e., if you buy one wheat futures contract at a price of F per bushel, you are contracting to purchase 5,000 bushels of wheat on the futures expiration date at a cost of (5000 x F ) dollars.] (a) Should the farmer buy or sell futures to hedge himself against changes in the price of wheat? How many contracts should he buy/sell? (b) What is the net profit the farmer will make on his harvest, assuming he carries out the
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