Homework Assignment 2; Due February 8, 2018 (Beginning of Class)
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1 Name: Econ 337 Agricultural Marketing, Spring 2018 Homework Assignment 2; Due February 8, 2018 (Beginning of Class) 1) A summer backgrounder operator decided to hedge 750 pound feeder steers to be sold in October. He/she sold October futures at $ per cwt and expected basis to be $7.960 per cwt for the quality of steers they will be selling. Assume brokerage commission is $60/round turn or $0.150 per cwt. a) What price does the backgrounder think they have locked in for these steers come October? Futures price at which futures contract is sold + Expected basis Expected selling price = $ per cwt Parts b and c are stand alone questions using this same initial position from question 1. b) In October, the backgrounder sells the steers for $ per cwt and closes his/her futures contract at a price of $ per cwt. -what is the gain/loss on the futures position? Sold OCT FC futures Offset (buy) OCT FC futures Net gain on futures transaction = -$ per cwt -what did basis turn out to be? Cash Futures = Basis = $ per cwt 1
2 -what is the net selling price on the calves? Price received in cash market + Net on futures transaction Net selling price = $ per cwt -Is the expected selling price equal to the net selling price? If yes, why? If not, why not? The expected selling price is not equal to the net selling price. It would have been if the expected basis equaled the actual basis. Basis strengthened or widened or improved. Because basis strengthened from what was expected the net selling price was higher than the expected selling price. c) Forget part b! In October, the backgrounder sells the steers for $ per cwt and closes his/her futures contract at a price of $ per cwt. -what is the gain / loss on the futures position? Sold OCT FC futures Offset (buy) OCT FC futures Net gain on futures transaction = -$7.450 per cwt -what did basis turn out to be? Cash Futures = Basis = $7.090 per cwt 2
3 -what is the net price on the calves? Price received in cash market + Net on futures transaction Net Selling Price = $ per cwt -Is the expected selling price equal to the net selling price? If yes, why? If not, why not? The expected selling price is not equal to the net selling price. It would have been if the expected basis equaled the actual basis. Basis weakened or narrowed or decreased. Because basis weakened from what was expected the net selling price was lower than the expected selling price. 2) Go back to the scenario set up in problem #1. A summer stocker operator decided to protect cattle to be sold in October. October futures are trading at $ per cwt and basis is expected to be $7.960 per cwt for the quality of steers they will be selling. However, instead of a straight hedge, the backgrounder decided to purchase a put option with a $135 strike price for $4.900 per cwt. Assume brokerage commission is $30 ($0.075/cwt) to buy an option contract and $30 ($0.075/cwt) to sell offset a futures position. a) What price floor does the backgrounder think they have set? Option strike price Put premium Futures equivalent + Expected Oct basis Maximum possible commission Price floor = = $ per cwt 3
4 Parts b and c are stand alone questions using this same initial position from question 2. b) In October, the backgrounder sells the steers for $ per cwt. The futures price has risen to $ per cwt. Does the backgrounder want to excise his/her option? No. Actual price is greater than the price floor. Prices went up after the Put Option purchase and the Put Option buyer retained the right to benefit from future price increases. -What will be the net price for the calves? Cash market price + Net on option trade Net price = $ per cwt c) In October, the backgrounder sells the steers for $ per cwt. The futures price has fallen to $ per cwt. Does the backgrounder want to excise his/her option? Yes. Actual price equals the price floor. Prices went down after the Put Option purchase and the Put Option buyer retained the right to sell futures. -What will be the net price for the calves? Cash market price + Net on option trade Sold OCT FC $ Offset (buy) OCT FC $ Brokerage Commission Net price = $
5 3. This question is designed to give you some practice using spreadsheets and estimating basis for feeder cattle. Use the CombinedAuctionIA-Feeder Cattle Cash Prices and Feeder Futures Prices spreadsheets to estimate basis for each month and each year for feeder cattle. Calculate the 5-year average basis by month. Using a spreadsheet will be much quicker than doing this by hand. Write your basis estimates into the table below, or attached a print out of the table. Combined Iowa auction feeder cattle basis, for lb no. 1 steers ($/cwt) Market Contract yr Avg Period For Basis Basis Basis Basis Basis Basis Basis January January February March March March April April May May June August July August August August September September October October November November December January Notes: 1/ Basis is calculated as Cash - Futures. A negative sign means that futures are greater than cash. 2/ Cash price is for large and medium frame steers. Describe the seasonal basis pattern for Iowa lb large and medium frame no. 1 steers. You can just describe the basic seasonal pattern and in which month basis is the highest and lowest. Also note if there is a month that seems like an outlier. Using the 5-year average calculation to describe would be appropriate. In general, Iowa lb large and medium frame no. 1 steer basis is narrow (weakest) in the first half of the year and widest (strongest) in the second half of the year. July is the highest and January is the lowest. November appears to be an outlier as basis goes from $7.49/cwt in October to $4.22/cwt in November to $8.18/cwt in December. 5
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