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Diamonds are Forever PowerPoint PPT Presentation

GERKENS Cacao Diamonds are Forever GERKENS Cacao About hedging Price Risk of Goods. J.A.C. Rietveld 28 th June 2007 How to hedge? GERKENS Cacao A Future Market could give you the solution!! There, you can buy and sell “futures” contracts. A futures contract is a:

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Diamonds are Forever

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GERKENS Cacao

Diamonds are

Forever


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GERKENS Cacao

About hedging Price Risk of Goods.

J.A.C. Rietveld

28th June 2007


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How to hedge?

GERKENS Cacao

A Future Market could give you the solution!!

There, you can buy and sell “futures” contracts.

A futures contract is a:

“financial product through which a buyer and seller undertake to exchange a particular quantity of a commodity or financial instruments at an agreed price on a stipulated future date”.


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How to hedge?

GERKENS Cacao

The good thing about these contracts is that youdon’t need to deliverphysicalsimmediately.

The Future contracts are based on a standard quality

and a standard quantity

The other good thing is that these contracts have a

unique counterpart, the clearing house.So when you had sold some contracts, if you don’t want to

deliver the goods, you just have to buy other contractsand the clearing house willcancel/washthem out.


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Exchange

Contracts

made here

Order

Order

Seller

Buyer

Contract

Clearing House

Paper Trade Flow

GERKENS Cacao

Contract


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GERKENS Cacao

HEDGING

1.What is a future market and how does it work

2.What do you need for a good and smooth working future market.

3.How to manage RISK of volatile markets by hedging.


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GERKENS Cacao

HEDGING

1.What is a future market and how does it work

A future market is like a stock market

1. You can buy and sell in the future

2. You can hedge your risk of physical business

3. A future market reflects the underlying, physical world market

on which you can deliver and on which you can take delivery

4.A future market reflects the supply/demand situation of the underlying,

physical world market


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HEDGING

GERKENS Cacao

2.What do you need for a good and smooth working future market.

a) A standard contract, with a standard quantity and quality

b) Enough participants (players), hedgers , investors and speculators

to secure liquidity

c) An exchange where buyers and sellers find each other, screen trading

or open out cry, could be with an existing exchange


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HEDGING

Do you like risks?

GERKENS Cacao

3.How to manage RISK of volatile markets by hedging.

Is trading DIAMONDS a RISKY business

Either you like risks:

you SPECULATE.

Or you don’t like risks:

you want to HEDGE.


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Trading

GERKENS Cacao

  • Hedging, the futures market

  • Differential

  • Speculators

A lot of similarities between the Pricing of Diamonds and Cocoa.

A kind of basis products with a basis world price and

a lots of different products, quality differences, with a price difference

to the basis market price

A DIFFERENTIAL

Here after the presentation will be about COCOA

FOR YOU PLEASE READ

DIAMONDS

FOR

COCOA


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Buy

Sell

x

x

Buy

x

x

Sell

Price fluctuations.

GERKENS Cacao

Price

per ton

$ 1500

$ 500

Time

CASE 2

CASE 1

Because of strong price fluctuations,

trading cocoa beans is a RISKY business.


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GERKENS Cacao

Hedging

The futures market


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How to hedge?

GERKENS Cacao

The best hedge against price fluctuations would be to NEVER keep positions…

As soon as you BUY cocoa,

you SELL it immediately.

And as soon as you SELL cocoa,

you BUY it immediately.

But this may be difficult since good buyers and good sellers of cocoa stocks are not easy to findat the exact same time.


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Whenever you buy a quantity of beans (physical),

Whenever you buy a quantity of beans (physical),

Whenever you sell a quantity of beans (physical),

Whenever you sell a quantity of beans (physical),

Buy / Sell

Buy

x

you sell the same quantity on the New-York or London market for a later delivery (paper contract).

you buy back the same quantity on the New-York or London market (paper contract).

$ 500

x

Sell / Buy

Sell

Cocoa sale

New-York

Price hedging.

GERKENS Cacao

Price

per ton

$ 1500

Time

The money you LOOSEwith the physical cocoa

is compensated by

the money you GAINwith the “paper” cocoa.


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Cocoa sale

New-York

Price hedging when prices go up.

Price

per ton

$ 1500

Sell / Buy

x

$ 500

x

Buy / Sell

Time

The money you GAINwith the physical cocoa

is compensated by

the money you LOOSEwith the “paper” cocoa.


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Price hedging.

GERKENS Cacao

Whether prices go up or go down,the physical cocoa price risk (gain/loss)

will be compensatedby the “paper” cocoa price risk (loss/gain).


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GERKENS Cacao

Differentials


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Cocoa sale

-

New-York

Ivory Coast

Differential.

GERKENS Cacao

The hedge by using New York or London markets is not perfect because the price of the physical cocoa is rarely equal to the price of the “paper” cocoa.

The difference is called DIFFERENTIAL.

=

DIFFERENTIAL


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Cocoa sale

-

New-York

Ivory Coast

Differential.

GERKENS Cacao

Indeed, contracts in New-York and Londonare STANDARDIZED and cannot reflectthe full reality of physical bean stocks.

The DIFFERENTIAL depends on:

- the quality of the bean (origin, bean size, defects…)

- the supply and demand of this origin and quality

- the location and format of the stock

=

DIFFERENTIAL


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A trader seeksthe differential price riskand hedge himself fromLondon or New-Yorkprice change risk.

A speculator seeksthe London or New-Yorkprice change risk.

Managing risks.

GERKENS Cacao

PhysicalLondon bean price (reference) Differential

Buy: £1545£1500£45

=

+

Sell:£565£500£65

Balance:£-980£-1000£+20


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Speculators

GERKENS Cacao

Very much needed they bring liquidity into a market

  • “Speculators” or “Hedge Funds” frequently enter the market

  • There are several kinds:

    • Those that trade on fundamental information

    • Those that trade on technical analysis: “reading the charts”

    • Pension funds that invest in commodities


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Speculators

GERKENS Cacao

  • They have so much money, they can push markets in a certain direction.

  • This can create opportunities if it is against the fundamentals

  • The last 2 big price moves in the last 2 years were caused by hedge funds buying the market and then selling it off again


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GERKENS Cacao

END


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