2. You are a coffee dealer anticipating the purchase of 82,000 pounds of coffee in threemonths. You are concerned that the price of coffee will rise, so you take a long positionin coffee futures. Each contract covers 37,500 pounds, and so, rounding to the nearestcontract, you decide to go long in two contracts. The futures price at the time you initiateyour hedge is 55.95 cents per pound. Three months later, the actual spot price of coffeeturns out to be 58.56 cents per pound and the futures price is 59.20 cents per pound.a. Determine the effective price at which you purchased your coffee. How do youaccount for the difference in amounts for the spot and hedge positions?b. Describe the nature of the basis risk in this long hedge.

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Asked Feb 9, 2020
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2. You are a coffee dealer anticipating the purchase of 82,000 pounds of coffee in three
months. You are concerned that the price of coffee will rise, so you take a long position
in coffee futures. Each contract covers 37,500 pounds, and so, rounding to the nearest
contract, you decide to go long in two contracts. The futures price at the time you initiate
your hedge is 55.95 cents per pound. Three months later, the actual spot price of coffee
turns out to be 58.56 cents per pound and the futures price is 59.20 cents per pound.
a. Determine the effective price at which you purchased your coffee. How do you
account for the difference in amounts for the spot and hedge positions?
b. Describe the nature of the basis risk in this long hedge.
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2. You are a coffee dealer anticipating the purchase of 82,000 pounds of coffee in three months. You are concerned that the price of coffee will rise, so you take a long position in coffee futures. Each contract covers 37,500 pounds, and so, rounding to the nearest contract, you decide to go long in two contracts. The futures price at the time you initiate your hedge is 55.95 cents per pound. Three months later, the actual spot price of coffee turns out to be 58.56 cents per pound and the futures price is 59.20 cents per pound. a. Determine the effective price at which you purchased your coffee. How do you account for the difference in amounts for the spot and hedge positions? b. Describe the nature of the basis risk in this long hedge.

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Expert Answer

Step 1

a)
Given that;
We entered into the long position at a price of 55.95 cents per pound
Future price after three months is 59.20 cents per pound

Step 2

Gain equals to 59.20 subtracted by 55.95 which is equal to 3.25 per pound.
Actual spot price of coffee is 58.56 cents per pound.

Now, the effective price for 75,000 pounds (long position in two contracts with each contract covering 37,500 pounds) is:

Finance homework question answer, step 2, image 1

Step 3

When we purchased two contracts for 75,000 pounds and at 55.95 cents per pound, it results in an un...

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