A farmer that grows strawberries will after the summer need to purchase new machinery, and is therefore a bit concerned about what the demand will be like around midsummer. The farmer ask you for help and wonder if you know a way of insuring the profits.
The correlation between strawberry- and umbrella- prices are -1.
Which of the following contracts would you recommend the farmer:
Select one:
a. Do nothing, the demand will obviously be great!
b. Go short on forward contract(s) on strawberries.
c. Go short a put option on strawberries
d. Go short on futures contract(s) on umbrellas
e. Go long on futures contract(s) on strawberries
Answer: b. Go short on forward contract(s) on strawberries.
The farmer is afraid of strawberry price falling. He should hedge his position in such a way that if strawberry price falls, he gets a profit from it.
In this case when he goes short on forward contract(s) on strawberries, as the price falls he will get the money. So that he will be able to recover his money from forward contract when the prices fall.
Incorrect:
a,c,d,e.
When he goes short a put option on strawberries. He will benefit if the prices rise and not fall. He will lose money when the price falls.
Go short on futures contract(s) on umbrellas means going long on futures contract(s) on strawberries. As they are -1 correlated. In both these cases, He will benefit if the prices rise and not fall. He will lose money when the price falls.
A farmer that grows strawberries will after the summer need to purchase new machinery, and is...
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