Future Contract choices for hedging price of frozen orange juice
On January 1, a contract was signed to deliver 60,000 pounds of frozen orange juice on May 1 (exactly 4 month away). Ms. Smith signed the contract. Ms. Smith plans to buy the orange juice from a local distributor in May. With a small profit margin, though, Ms. Smith is afraid she might incur a loss if orange juice prices increases.
- Explain how Ms. Smith could lock in her orange juice costs with a May frozen orange juice futures contract trading in January.
- Assume on January 1, the orange juice price on the spot market is $0.91/lb. What is the future price, assuming risk-free rate is 1% per month?
- Assume one future contract delivers 15,000 pounds of orange juice. How many future contracts Ms. Smith needs to acquire in January?
- Show in the following table Ms. Smith’s net costs (or profits), at the futures expiration date, from buying 60,000 pounds of frozen orange juice at the price stated on the future contract, while on the spot market orange juice spot prices are $0.90/lb, $0.95/lb, and $1.00/lb.
Spot price on May 1 Net loss (or profit)
- Assume on March 1 (exactly 2 months away from expiration), the orange juice price on the spot market is $0.98/lb. What is the value of Ms. Smith’s future contract, assuming monthly risk-free interest rate is 1%