AGBM320 HW5 Business Memo

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School

Pennsylvania State University *

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Course

320

Subject

Finance

Date

Jan 9, 2024

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pdf

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Uploaded by MinisterExploration19558

11/7/22 Hens, Hens, Hens! Business Memo While analyzing the egg and corn prices (also corn adjusted price) with their average returns I was able to calculate the upper and lower 95% return of these commodities. First I calculated eggs' average return by using its annualized return standard deviation of 14.58% and its average return of 1.00% to get a result of an upper 95% return of 30.15% and a lower 95% of -28.15%. Clearly there is some volatility here, but it could be worse (which will we see later with another commodity). With this information and today’s spot price of egg, $1.49, I was also able to calculate the expected price, upper 95% price and lower 95% price which will give more indication of the volatility of egg per year. The expected price of eggs in 1 year is $1.50, with an upper 95% bound of $1.93 and a lower 95% bound of $1.07. The volatility of these prices aligns with the average return we calculated earlier. Nextly, I calculated these same variables but with the other commodity, corn. The annualized return standard deviation of corn is 17.54% and the average return is 1.50%, to get an upper 95% return of 36.59% and a lower 95% return of -33.59%. As previously said this commodity is predicted to see slightly more volatility than eggs. Moving forward with this information I calculated the price predictions for a year ahead, which resulted in an expected price of $4.00, upper 95% price bound of $5.38 and a lower 95 % bound of $2.62. Again, we can see this commodity is more likely to fluctuate than egg. I was told Hens, Hens, Hens! needs to manage the gross margin, so I created a gross margin matrix table to indicate which would be profitable, while keeping in mind their fixed costs. This table can be seen here: Based on the fixed cost Hens, Hens, Hens! needs the gross margin to be above $1.00. While analyzing this table there is a 55.5% (5/9) likelihood this company will be profitable given my calculations.

Looking into future contracts for Hens, Hens, Hens! to be able to sell 100,000 eggs next year, each contract will be 1,000 per. Today the future price contract which expires in 12 months is $1.500 per dozen. Using this I calculated different hedge ratios values (0,0.5, 1), to give an effective hedger price. I used possible future and spot prices to help with this. Hedging more will reduce the overall risk of a potential spike of a commodity, but in turn will provide a smaller reward for that contract. So, a 0 hedge ratio I would advise against, especially in dealing with commodities which we have seen are volatile. A .5 hedge ratio would be ok because it has an average chance of going your way, but if the market makes drastic changes it could hurt you and vice versa with going your way (you could make major profits). A 1 hedge ratio can play it safe, but don’t expect to make large profits. To give you a better understanding of this I will provide you a graph of what I calculated; it can be seen here: For my last calculation I wanted to give you an idea of what to expect in return for short hedging eggs, and also long hedging corn. For eggs, I used my previous predicted price value (expected price of $1.500, upper 95% of $1.933 and lower 95% of $1.067), with different hedge ratios to give you an understanding of how each hedge ratio can impact the range of possible effective prices. For eggs, here is my prediction with a visual. I advise you to hedge at a ratio of 0.65 to be 95% confident that the egg EHP is at least $1.350.

Then looking at the corn hedge, and using the information previously predicted I was also able to give you the same type of prediction as I just did. This can be seen here: I advise you to hedge at a ratio of 0.93 to be 95% confident that the egg EHP is at most $4.10. The hedge ratio is the determinant of the range of possible effective prices because it measures the risk of the investment. The lower the hedge ratio the more volatility it can be, and vice versa. Sticking to a 1 hedge ratio guarantees the expected price because you are fully hedged. You will be 95% confident that their gross margin will be at least $0.94. I would advise you to utilize these hedge ratios to give you the best outcome.

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