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FRM Part I · FRM Exam Part I · Commodity Forwards and Futures

A cattle feeder is short hedged. Over the hedge period the basis (spot minus futures) moves from -2.00 to -0.50. Relative to the originally expected outcome, which is correct?

The short hedger benefits by 1.50 per unit because the basis strengthened from -2.00 to -0.50. A short hedger's realized price equals the initial futures price plus the closing basis, so a higher basis raises the price received.

  1. AThe hedger benefits by 1.50 per unit because the basis strengthenedCorrect
  2. BThe hedger loses 1.50 per unit because the basis strengthened
  3. CThe hedger benefits by 1.50 per unit because the basis weakened
  4. DThe hedger loses 1.50 per unit because the basis weakened

Explanation

For a short hedger, effective price = initial futures price + closing basis. The basis rose from -2.00 to -0.50, a strengthening of 1.50, which raises the realized price by 1.50 relative to the expectation.

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