A wheat merchant keeps some basis risk
Series XVI practice case · 4 questions · 1 mark each
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A merchant holds 100 tonnes of wheat and expects to sell all of it in one month. To reduce the risk of a price fall, it sells futures at ₹25,000 per tonne. The hypothetical contract size is 10 tonnes, and the merchant hedges the whole physical quantity. One month later, the wheat is sold at a local cash price of ₹24,000 per tonne and the futures position is closed at ₹24,200 per tonne. Basis is defined here as cash price minus futures price. Ignore quality differences, taxes, storage, financing, delivery costs and brokerage. The futures contract is closed, so no exchange delivery occurs.
Contract size and prices are fictional teaching inputs.
Cash price and futures price need not be equal at hedge closure.
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The case and its answers
Every question of this case, with its answer and why each other option is wrong.
A merchant holds 100 tonnes of wheat and expects to sell all of it in one month. To reduce the risk of a price fall, it sells futures at ₹25,000 per tonne. The hypothetical contract size is 10 tonnes, and the merchant hedges the whole physical quantity. One month later, the wheat is sold at a local cash price of ₹24,000 per tonne and the futures position is closed at ₹24,200 per tonne. Basis is defined here as cash price minus futures price. Ignore quality differences, taxes, storage, financing, delivery costs and brokerage. The futures contract is closed, so no exchange delivery occurs.
Contract size and prices are fictional teaching inputs.
Cash price and futures price need not be equal at hedge closure.
Q1How many futures contracts are required for the stated full-quantity short hedge?
Option A. Sell 10 contracts — Correct answer
Option B. Sell 100 contracts
Why it is wrong: This hedges 1,000 tonnes at the stated contract size.
Option C. Buy 10 contracts
Why it is wrong: Buying futures adds exposure to falling wheat prices rather than offsetting it.
Option D. Sell 1 contract
Why it is wrong: This hedges only 10 tonnes.
Answer: A. Contracts = 100 ÷ 10 = 10, sold short because the merchant owns the commodity and fears a price fall. Remember: Match hedge direction and quantity to the physical exposure.
Hint, shown before you answer in practice mode: Divide tonnes held by tonnes per contract.
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Q2What is the total futures gain?
Option A. ₹80,000 — Correct answer
Option B. ₹8,000
Why it is wrong: This is the gain on only one 10-tonne contract.
Option C. A loss of ₹80,000
Why it is wrong: A short futures position gains when the futures price falls.
Option D. ₹1,00,000
Why it is wrong: This uses the cash sale price rather than the futures closing price.
Answer: A. Futures gain = (₹25,000 − ₹24,200) × 100 = ₹80,000. Remember: Futures profit uses futures prices, not the physical sale price.
Hint, shown before you answer in practice mode: Use the futures entry-to-exit price difference on 100 tonnes.
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Q3What is the combined cash sale value plus futures gain?
Option A. ₹24,00,000
Why it is wrong: This omits the hedge gain.
Option B. ₹25,00,000
Why it is wrong: This assumes the physical and futures prices converge to the same closure price.
Option C. ₹24,80,000 — Correct answer
Option D. ₹23,20,000
Why it is wrong: This subtracts the short futures gain.
Answer: C. Combined proceeds = 100 × ₹24,000 + ₹80,000 = ₹24,80,000. The effective price is ₹24,800 per tonne. Remember: A hedge can reduce price risk while leaving basis risk.
Hint, shown before you answer in practice mode: Add ₹24,00,000 physical proceeds to the futures gain.
XVI-P-C01-Q3mediumnumerical
Q4What is the closing basis under the case definition?
Option A. +₹200 per tonne
Why it is wrong: This reverses the specified cash-minus-futures definition.
Option B. −₹1,000 per tonne
Why it is wrong: This compares the closing cash price with the opening futures price.
Option C. −₹200 per tonne — Correct answer
Option D. Zero
Why it is wrong: Cash and futures close at different stated prices.
Answer: C. Closing basis = cash − futures = ₹24,000 − ₹24,200 = −₹200 per tonne. That difference explains why the effective price is below ₹25,000. Remember: Always state the convention used for basis.
Hint, shown before you answer in practice mode: Subtract ₹24,200 from ₹24,000.
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