Answers to Chapter Review and Self Test Problems

23.1 GGF wants to deliver wheat and receive a fixed price, so it needs to sell futures contracts. Each contract calls for delivery of 5,000 bushels, so GGF needs to sell 10 contracts. No money changes hands today.

If wheat prices actually turn out to be $3, then GGF will receive $150,000 for its crop, but it will have a loss of $50,000 on its futures position when it closes that position because the contracts require it to sell 50,000 bushels of wheat at $2, when the going price is $3. He thus nets $100,000 overall.

If wheat prices turn out to be $1 per bushel, then the crop will be worth only $50,000. However, GGF will have a profit of $50,000 on its futures position, so GGF again nets $100,000.

23.2 If GGF wants to insure against a price decline only, it can buy 10 put contracts. Each contract is for 5,000 bushels, so the cost per contract is 5,000 X $.15 = $750. For 10 contracts, the cost will be $7,500.

If wheat prices turn out to be $3, then GGF will not exercise the put options (why not?). Its crop is worth $150,000, but it is out the $7,500 cost of the options, so it nets $142,500.

If wheat prices fall to $1, the crop is worth $50,000. GGF will exercise its puts (why?) and thereby force the seller of the puts to pay $2 per bushel. GGF receives a total of $100,000. If we subtract the cost of the puts, we see that GGF's net is $92,500. In fact, verify that its net at any price of $2 or lower is $92,500.

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