Starbucks needs coffee in December 2023. The December 2023 futures contract is trading at 25 cents per pound today. Starbucks calls a coffee exporter they have been doing business with for years. The exporter agrees to sell Starbucks 150,000 pounds of coffee at "Dec-5."

Assume that the December 2023 price moves to 350 cents per pound near the end of December 2023. Starbucks should carry out a specific hedging strategy to minimize risk. Assume that Starbucks did not take IMS 3310 and instead opted to "see what the market does," agreeing to pay the exporter the "Dec-5" in December 2023 based on the new market price, whatever it may be. The price rises to 350 cents per pound. Starbucks and the exporter agree to settle their deal based on this new price of 350 cents per pound, less the 5-cent discount.

How much could Starbucks have saved had they executed the hedging strategy learned in class?

A. Starbucks could have saved $487,500.
B. Starbucks could have saved $525,000.
C. Starbucks could have saved $30,000.
D. Starbucks could have saved $35,000.

By neglecting to hedge their risk exposure to coffee prices through a futures contract, Starbucks ended up paying a higher price when the market price of coffee rose significantly.

Explanation:

The question is related to financial risk management, specifically the use of futures contracts for hedging commodity price risk. In this case, Starbucks had the opportunity to hedge its risk exposure to coffee prices by locking in the price through a futures contract. However, Starbucks chose not to do so, hence, exposed to the risk of price increases.

At the beginning, the Dec. 2023 futures contract was trading at 25 cents per pound. If Starbucks had purchased it, the cost would be fixed at this rate. However, by the end of Dec. 2023, the price of coffee had increased to 350 cents per pound. Had they hedged, Starbucks would have only paid 25 cents (contract price) instead of 345 cents (the market price minus the Dec-5 discount). Therefore, the potential savings would be (345 - 25) cents = 320 cents per pound.

To find out how much Starbucks could have saved in total, we then multiply this savings per pound by the total number of pounds Starbucks had bought: 320 cents/pound * 150,000 pounds = 48,000,000 cents = $480,000. Thus, had Starbucks used the hedging strategy we learned in class, they could have saved $480,000.

Learn more about Futures contracts here:

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