Johnson Family Farm Case
Frank Johnson, who owns the Johnson Family Farm, was considering whether or not to hedge his corn crop prior to the planting season for the upcoming year. He had three choices: first, not hedging at all; second, hedging using traded future contracts; third, hedging using Cargill’s Pacer product. If Frank chose to not hedge, the total cost of this choice is the elevator operator’s profit and the transportation costs (which totally Frank set the basis as 0.15). And the benefit is that there is no limit on the upward revenue. This means that no matter how high is the spot price at the delivery date, Johnson Family Farm (JFF) could sell their corn at the high price. However, this unlimited upward revenue stands with the huge risk that there is also no limit on the downward loss. If the corn price dropped substantially in December 2011, JFF had to deliver their product by accepting the lower price compared to the price now which is $5.83 per bushel. Because the USDA predicted that the projected corn carryover would be about 827 million bushels, a historical low number, which leaded to a compared low average price $5.2 estimated by USDA. Although Frank expected the price to improve but the uncertainties cannot be ignored easily. Since the corn price in the past ten years fluctuated dramatically ranging from $2 per bushel to $7 per bushel, the current price $5.83 per bushel seemed attractive. Thus Frank can choose the second choice: sell futures contracts to lock in today’s futures price for delivery. JFF own a 5,000 acres farm in north central Illinois and the expected corn production is 185 bushels per acre. The total production is about 1 million bushels while JFF hedged approximately 25% historically so the amount JFF needed to hedge is 250,000 bushels, which means Frank needed to buy 50 futures contracts of December 2011 with each contract containing 5,000 bushels of corn. The total costs were $100 per contract for broker’s fee and...
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