FIN358: The CFO of Wheat Inc. is deciding whether to use options, futures or forwards to hedge the price of its wheat production: Fixed Income and Derivative Securities Assignment, SUSS, Singapore

Question

• The CFO of Wheat Inc. is deciding whether to use options, futures or forwards to hedge the price of its wheat production. Appraise the three (3) choices, rank them, and explain the rankings:

i. Rank from lowest to highest cost, given that the wheat price at harvest is predicted to be higher than the price when the wheat was hedged.
ii. Rank from lowest to highest risk, given that the wheat price at harvest is predicted to be lower than the price when the wheat was hedged.

• Jenny, a new trader in the commodity market, was observing the change in the transaction volume for an oil futures contract and the change in the open interest. She was puzzled by the seeming lack of correlation between the two variables of transaction volume and open interest. She is puzzled why the open interest can decrease one day despite a higher transaction volume compared to the day before, increase when the transaction volume went down, or remain the same, whether the transaction volume went up or down. Analyze and explain how the three (3) situations can arise.
• Tom and his friend Jerry, both commodity traders, are having a discussion about the market. “Times are hard these days,” says Tom. “In previous years, I could make a fair amount of profit from today’s spot and 1-year futures prices for oil of $60 and $63, respectively. Today these prices allow me to barely cover my costs.” Appraise the situation Tom is talking about and give three (3) reasons that could explain his last statement.