I'm taking a financial engineering course through coursera and on a slide one of the lecturers talks about how a long hedge is used in the futures market. Here is the text:
Today is Sept 1st. A baker needs 500,000 bushels of wheat on December 1st. So, the baker faces the risk of an uncertain price on Dec. 1st.
Hedging strategy: buy 100 futures contracts maturing on Dec 1st - each for 5000 bushels
It goes on to talk about the cash flows on Dec 1st. (numbering mine):
- Futures position at maturity: $F_T - F_0 = S_T - F_0$
- Buy in the spot market: $S_T$
- Effective cash flow: $S_T - F_0 - S_T = -F_0$
However, the lecturer glosses over how (3) is arrived at.
So my questions are as follows:
for (2) - why are we buying in the spot market? Shouldn't the baker be taking delivery of the underlying and therefore already own the underlying?
How is (3) arrived at algebraically? I can see how (1) is mutated into it, but I'm wondering the reasoning behind how the $-F_0$ got there, as well as the second $S_T$ (which I'm assuming comes from (2).
Thank you! It's been a while since I've messed with this stuff and it sure shows.