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Company Z wishes to hedge its exposure to cotton with corn futures over the next three months
Company Z wishes to hedge its exposure to cotton with corn futures over the next three months. The market price of cotton per ton and future price of corn per ton for 8 months are given. The company has an exposure to the price of 1000 tons of the cotton. Each futures contract is on 42 tons of corn. How many corn contracts should be traded? (Answer is rounded)
| Month | Corn future price per ton | Cotton price per ton |
| 1 | 175 | 1770 |
| 2 | 165 | 1776 |
| 3 | 172 | 1788 |
| 4 | 182 | 1791 |
| 5 | 177 | 1789 |
| 6 | 189 | 1885 |
| 7 | 179 | 1902 |
| 8 | 184 | 1910 |
Which answer:
A . 88
B. 133
C. 41
D. 24
E. 48
Expert Solution
Since this is a case of cross hedge i.e. Underlying of the future contract (Corn) and exposure (Cotton) are not same, we should use the concept of Optimal Hedge Ratio. But here we don't have any information related to that, so we can assume that hedge ratio would be 1. It is assumed that the data given above is for next 8 months of future contract. So,
No. of Contracts Needed = Cotton priceper ton *exposure cotton /corn price per ton *future contract size
If using the data for 1st Month,
No. of Contracts Needed = {1770 * 1000}/{175 * 42} = 41.45Contracts
So, 41 contracts of Corn needs to be traded.
SO OPTION C IS CORRECT
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