when the future price isn't predetermined..

[young_]

In the notes...
---
2. To a key customer, the coffee producer promises to sell 100 pounds, on a date one year in the future, at the future spot price


In the second scenario, the producer is exposes to a future spot price decrease, such that the appropriate hedge is a short position in coffee futures contracts. In this case as the future sale price is not predetermined, the underlying exposure is effectively a short position such that the hedge instrument is a long position.
---

I'm confused by the last sentence...isn't the underlying exposure is a long position since the producer is exposes to a decreasing future price? so wouldn't the hedging side be a short postion?

please let me know if I'm missing something here...

thanks in advance.

 

[ShaktiRathore]

Hi there,
So the case illustrates that the coffee producer promises to sell 100 pounds, on a date one year in the future, at the future spot price so the producer is effectively long in the underlying exposure so that if the spot price increase he profits and if the spot price decrease he loses. To protect from this price movements he should enter short position in the futures contract so as to protect from downside movement of the prices and producer locks in the price at the outset. If seen from the side of the counter-party to the producer the underlying exposure is effectively a short position such that the hedge instrument is a long position.

thanks

 

[David Harper CFA FRM]

Hi cypanic,

It's our typo, you are correct, apologies (tagged for fix), it should read as below (emphasis mine), I just added this section on the most recent version to highlight the huge difference between a promised sale of future quantity + price, as opposed to quantity only (based on insightful forum comments), but i got the final sentence wrong. Thank you!

A key difference: is the future price predetermined?
Consider two scenarios for a coffee producer that plans to sell 100 pounds of coffee on a future date:

1. To a key customer, the coffee producer promises to sell 100 pounds, on a date one year in the future, at $3.00 per pound.
2. To a key customer, the coffee producer promises to sell 100 pounds, on a date one year in the future, at the future spot price

If the coffee producer wants to hedge with coffee futures, is the hedge the same for both? No, they are different!

1. In the first scenario, the producer is exposed to a future spot price increase, such that the appropriate hedge is a long position in coffee futures contracts. Because the sales price of $3.00 is predetermined, the underlying exposure is effectively a short position, such that the hedge instrument is a long position to offset.
2. In the second scenario, the producer is exposes to a future spot price decrease, such that the appropriate hedge is a short position in coffee futures contracts. In this case as the future sale price is not predetermined, the underlying exposure is effectively a short position such that the hedge instrument is a short position

 

[CoinDrop]

hi
it seems the Hull study notes still contain the typo - the underlying exposure is a long position for scenario 2, correct?

sorry if this is not the right forum to ask, but in general when typos are found and corrected, how do we find out about them? mostly concerned if material we have already studied happened to have an error, how do we know if it was changed?

thank you

 

[David Harper CFA FRM]

Hi @CoinDrop Yes, sorry that typo remains. We will fix it in the next revision

Re: "how do we find out about them?" that's a great point. Copy @Nicole Manley : maybe we should just have a single errata post in the announcements forum?

 

[CoinDrop]

thanks for confirming David
a mass announcement of where the corrections will be posted would be great, just in case we are not monitoring the right forum.

 

[Nicole Seaman]

@CoinDrop,

I created a thread under "Announcements" entitled 2014 Errata. Thank you for pointing this out!

Nicole

 

[CoinDrop]

thank you for coming up with a solution so quickly!