AAEC 4317/5317: Fall 2016 Commodity Futures Trading and Analysis Hedging project
AAEC 4317/5317: Fall 2016
Commodity Futures Trading and Analysis
Hedging project: Due on 01Nov 2016
Name: _________
Suppose that you are the manager of a Texas Cattle feedlot. On 01 June2016, you bought 1,000 feeder cattle with the plan of feeding the animals until they reach an average weight of 1,200 pounds. You estimated that it would take approximately 5 months to finish the cattle and you plan to sell the fed cattlebythe end ofNovember2016.
On 01 June2016 the closing price for fed cattle in the local cash market was 130.00cents per pound. However, you are worried that the cash prices for live cattle will decrease during the November-December because of increased supply of fed cattle in the market, and you may not be able to recover the costs. So, you wanted to explore the possibility of devising a hedging strategy using CME Live Cattle Futures Contracts. You have obtained some historical data on cash and futures prices for live cattle during 2011-15(see the spread sheet sent to you by email).
Q1. Write down the formula for calculating the variance, standard deviation, covariance, and correlation coefficient of the cash and futures price series. (2 ×6 = 12 points)
Q2. According to the above formula, calculate the variance, standard deviation, covariance, and correlation coefficient of the cash and futures price series provided in the spreadsheet (show your calculation both in the spread sheet and below). (2 ×6 = 12 points)
Q3. Given the data, what is the cattle feeder’s cash price risk? What is the cattle feeder’s futures price risk? (8 points)
Q4. What is the cattle feeder’s basis risk? Write down the formula for calculating basis risk and calculate the basis risk according to the formula using the data in the spreadsheet (show your calculation both in the spread sheet and below). (8 points)
Q5. What is your anticipated hedging efficiency? Write down the formula for calculating hedging efficiency(HE) and calculate the hedging efficiencyusing the data in the spreadsheet (show your calculation in the spread sheet as well). Would you hedg based on the calculated hedging efficiency? (10 points)
Q6. Write down the formula for calculating hedge ratio according to the naïve and econometric methods. Calculate the naïve (HRN) and econometric(HR*) hedge ratios using the data in the spreadsheet (show your calculation both in the spread sheet and below). (4 ×2 = 8 points)
Q7.You expects to have (1,000×1200 =) 1,200,000 pounds of live cattle upon the completion of feeding the animals. Write down the formula for calculating the number of futures contracts to be used in hedging that minimizes risk (with the hedge ratio). The size of the CME live cattle futures contract is 40,000 pounds. Using the naive hedge ratio (HRN), calculate the number of futures contracts (NFCN) the cattle feeder needed to hedge her cash position. (6 points)
Q8.Using the calculated econometric hedge ratio (HR*), calculate the number of risk minimizing futures contracts (NFC*) the cattle feeder needed to hedge her cash position. (6 points)
Q9.Suppose that you have hedged your cattle on feed by trading the risk minimizing number (NFC*, as calculated using the econometric hedge ratio) of December2016CME live cattle futures contract.On 20June2016, you placed hedge by selling the risk-minimizing number of October2016 CME Live Cattle futures contract at 114.20 cents per pound. The local cash price for live cattle at the time of placing hedge was 106.10 cents per pound (see the data file). You sold your fed cattle on 26October2016 in the local livestock market at the price of100.90 cents per pound and closed your hedge position at the same time. On 26October2016,theDecember2016live cattle futures settlement price was104.40 cents per pound. Show the hedging strategy in the following table and calculate the revenue from selling the live animals in the local cash market, gain/loss from the futures position, total revenue, and net realized price per pound of live animal. (15 points)
Q10. What would have happen if you had hedged using the naïve hedge ratio (HN) – i.e., use (NFCN)? Using the following table, calculate the revenue from selling the live animals in the local cash market, gain/loss from the futures position, total revenue, and net realized price per pound of live animal. Compare the results with the answers the last question. (15 points)
Commodity Futures Trading and Analysis
Hedging project: Due on 01Nov 2016
Name: _________
Suppose that you are the manager of a Texas Cattle feedlot. On 01 June2016, you bought 1,000 feeder cattle with the plan of feeding the animals until they reach an average weight of 1,200 pounds. You estimated that it would take approximately 5 months to finish the cattle and you plan to sell the fed cattlebythe end ofNovember2016.
On 01 June2016 the closing price for fed cattle in the local cash market was 130.00cents per pound. However, you are worried that the cash prices for live cattle will decrease during the November-December because of increased supply of fed cattle in the market, and you may not be able to recover the costs. So, you wanted to explore the possibility of devising a hedging strategy using CME Live Cattle Futures Contracts. You have obtained some historical data on cash and futures prices for live cattle during 2011-15(see the spread sheet sent to you by email).
Q1. Write down the formula for calculating the variance, standard deviation, covariance, and correlation coefficient of the cash and futures price series. (2 ×6 = 12 points)
Q2. According to the above formula, calculate the variance, standard deviation, covariance, and correlation coefficient of the cash and futures price series provided in the spreadsheet (show your calculation both in the spread sheet and below). (2 ×6 = 12 points)
Q3. Given the data, what is the cattle feeder’s cash price risk? What is the cattle feeder’s futures price risk? (8 points)
Q4. What is the cattle feeder’s basis risk? Write down the formula for calculating basis risk and calculate the basis risk according to the formula using the data in the spreadsheet (show your calculation both in the spread sheet and below). (8 points)
Q5. What is your anticipated hedging efficiency? Write down the formula for calculating hedging efficiency(HE) and calculate the hedging efficiencyusing the data in the spreadsheet (show your calculation in the spread sheet as well). Would you hedg based on the calculated hedging efficiency? (10 points)
Q6. Write down the formula for calculating hedge ratio according to the naïve and econometric methods. Calculate the naïve (HRN) and econometric(HR*) hedge ratios using the data in the spreadsheet (show your calculation both in the spread sheet and below). (4 ×2 = 8 points)
Q7.You expects to have (1,000×1200 =) 1,200,000 pounds of live cattle upon the completion of feeding the animals. Write down the formula for calculating the number of futures contracts to be used in hedging that minimizes risk (with the hedge ratio). The size of the CME live cattle futures contract is 40,000 pounds. Using the naive hedge ratio (HRN), calculate the number of futures contracts (NFCN) the cattle feeder needed to hedge her cash position. (6 points)
Q8.Using the calculated econometric hedge ratio (HR*), calculate the number of risk minimizing futures contracts (NFC*) the cattle feeder needed to hedge her cash position. (6 points)
Q9.Suppose that you have hedged your cattle on feed by trading the risk minimizing number (NFC*, as calculated using the econometric hedge ratio) of December2016CME live cattle futures contract.On 20June2016, you placed hedge by selling the risk-minimizing number of October2016 CME Live Cattle futures contract at 114.20 cents per pound. The local cash price for live cattle at the time of placing hedge was 106.10 cents per pound (see the data file). You sold your fed cattle on 26October2016 in the local livestock market at the price of100.90 cents per pound and closed your hedge position at the same time. On 26October2016,theDecember2016live cattle futures settlement price was104.40 cents per pound. Show the hedging strategy in the following table and calculate the revenue from selling the live animals in the local cash market, gain/loss from the futures position, total revenue, and net realized price per pound of live animal. (15 points)
| Date/Action | Cash Market | Futures Market |
| June 20, 2016 Action | CP = 106.10 cents/lb. | FP = 114.20 cents/lb. |
| _______ _____ Dec. 16 CME LC contracts @ ________ cents/lb. | ||
| Oct26, 2016 Action | CP = 100.90 cents/lb. | FP = 104.40 cents/lb. |
| ________ 1,000 cattle (1,200,000 lb.) @ ________ | _______ _____ Oct. 16 CME LC contracts @ ________ cents/lb. | |
| Gain / Loss = | ||
| Return from Cash Market | = | |
| Return from Futures Market | = | |
| Net Return from Cash and Futures Markets | = | |
| Net realized price of live cattle (cents/lb). | = | |
Q10. What would have happen if you had hedged using the naïve hedge ratio (HN) – i.e., use (NFCN)? Using the following table, calculate the revenue from selling the live animals in the local cash market, gain/loss from the futures position, total revenue, and net realized price per pound of live animal. Compare the results with the answers the last question. (15 points)
| Date/Action | Cash Market | Futures Market |
| June 20, 2016 Action | CP = 106.10 cents/lb. | FP = 114.20 cents/lb. |
| _______ _____ Dec. 16 CME LC contracts @ ________ cents/lb. | ||
| Oct26, 2016 Action | CP = 100.90 cents/lb. | FP = 104.40 cents/lb. |
| ________ 1,000 cattle (1,200,000 lb.) @ ________ | _______ _____ Oct. 16 CME LC contracts @ ________ cents/lb. | |
| Gain / Loss = | ||
| Return from Cash Market | = | |
| Return from Futures Market | = | |
| Net Return from Cash and Futures Markets | = | |
| Net realized price of live cattle (cents/lb). | = | |
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