Forward and Futures Contracts

Question

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?

Answer 1

Step 1: Calculate the cost of purchasing the coffee at the spot price.

82,000 × $0.5856 = $48,019.20

Step 2: Calculate the profit from the futures contracts.

Two contracts cover:

2 × 37,500 = 75,000 pounds

The futures price increased from $0.5595 to $0.5920 per pound.

Futures profit = 75,000 × (0.5920 - 0.5595)

Futures profit = $2,437.50

Step 3: Calculate the effective purchase price.

Net cost = Spot purchase cost - Futures profit

Net cost = $48,019.20 - $2,437.50

Net cost = $45,581.70

Effective price per pound:

$45,581.70 ÷ 82,000 = $0.555874

Final answer: The effective purchase price is approximately 55.59 cents per pound, or $45,581.70 total.

The difference between the spot and hedge positions occurs because the dealer purchased 82,000 pounds of coffee but hedged only 75,000 pounds using two futures contracts. The remaining 7,000 pounds were unhedged. Additionally, the spot and futures prices did not move by exactly the same amount, creating basis risk.