Introduction
Gerard has to understand working with different options to hedge the downside risk of the commodity prices in the market. However, to predict the prices, it was necessary to understandwhich changes in the mailbox price would have animpact on theprice of another commodity. So, we utilized the beta to predict the price of the commodity. Meanwhile, we calculated the prices of Class IV at $12.069, Class III at $13.6, Butter $1.13 and NFDM at $0.97. Furthermore, it was also identified that there is astrong positive relationship between the Mailbox price and Class III price. This shows that they are positively correlated with each other; if one increases then other would also increase. Similarly,Gerard should purchase put option to hedge the downside risk in the market.Also, the strike price should be $13.6 for Class III to hedge the downside of the price.
The price of the mailbox is assumed at the $12.5 in a given month. So, to calculate prices, it is necessary to understand that what changes in the mailbox price would have animpact on all categories of prices. Similarly, to understand what impact changes in Mailbox has on the prices of other commodities,it is necessary to take a look in depth at the situation at hand.
The mailbox price is set by the government and Gerard has no tool to predict the prices of the commodities in the coming days to hedge the downside risk. However, we can apply the concept of beta and use it to predict the prices of the commodities based on prices of themailbox.
The beta shows the sensitivity of the stock price with changes in the market.Assuming that today’s stock exchange market is down by 10%and a particular company has abeta of 0.8, that means the market has decreased by 10% and the stock price of that company with abeta of 0.8 would decline by 8%. This shows that the stock price of that company is less sensitive to the changes in the market.
Also, it is animportant question to know that why should mailbox price be used as abenchmark to predict the prices of other commodities. It is because, the mailbox is the simple milk price that still hasn’t been processed to produce the other category of products produced by processing the milk with different ways and techniques.
Similarly, if we apply that concept to predict the prices, we would be able to predict what changes in mailbox price would have animpact on the other category of products in the market.However, to approach the fare price of the product, it is important to know beta of each product's price to the mailbox price.
So, here we assume that beta of the mailbox is 1. Now, similarly, the beta of Class IV is 0.94, which means that if the price of mail box increases by $1, then the price of Class IV would increase by $0.93. Similarly, if the beta of Class III is 0.5 and there is a $1 change in mailbox price, then Class III prices would increase by the $0.5. See Exhibit 1...........
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