6. (i) A Rice Trader has planned to sell 22000 kg of Rice after 3 months from now. The spot price of the Rice is 60 per kg and 3 months Futures on…

(a) 6 (i) (a) The trader can mitigate its risk of reduced profit by hedging his position by selling Rice Futures. So, the gain on futures contract = (₹ 59 - 56) x 22,000 kg. = 66,000 Revenue from the sale of Rice = 22,000 x 56 = 12,32,000 Total Cash Flow = 12,32,000 +66,000 = 12,98,000 Cash Flow per kg. of Rice = 12,98,000 / 22000 = 59 So, Rice Trader's cash flow per kg. is equal to the futures price. This way his loss from physical sale is compensated by gain from the futures contract. (b) The effective realized price for its sale after 3 months if spot price is 57per kg and Future Price is 58per kg. The gain on futures contract = (₹ 59 - 58) x 22,000 kg. = 22,000 Revenue from the sale of Rice = 22,000 x 57 = 12,54,000 Total Cash Flow = 12,54,000 +22,000 = 12,76,000 Cash Flow per kg. of Rice = 12,76,000 / 22,000 = 58 (ii) (a) The optional hedge ratio to minimize the variance of Hedger's position is given by: H = ρ (σ S / σ F ) Where σ S = Standard deviation of ΔS (Change in Spot Prices) σ F =Standard deviation of ΔF (Change in Future Prices) ρ= coefficient of correlation between ΔS and ΔF H= Hedge Ratio ΔS = change in Spot price. ΔF= change in Future price. Accordingly Standard deviation of ΔS = √16% = 4% and Standard deviation of ΔF = √36% = 6% and H = 0.75 x (0.04 / 0.06) = 0.50 (b) Since the company is long position in Spot (Cash) Market it shall take Short Position in Futures Market. (c) Since contact size of one contract is 1,000 Kg, the No. of Futures contract to be short = (10,000 Kgs × 0.50) / 1,000 Kgs = 5 Contracts Amount = 5000 x 534 = 26,70,000