price risk management and the futures market l.
Download
Skip this Video
Loading SlideShow in 5 Seconds..
Price Risk Management and the Futures Market PowerPoint Presentation
Download Presentation
Price Risk Management and the Futures Market

Loading in 2 Seconds...

play fullscreen
1 / 32

Price Risk Management and the Futures Market - PowerPoint PPT Presentation


  • 208 Views
  • Uploaded on

Price Risk Management and the Futures Market. Hedging. Market Risk. Economic vs. Product Risk product deterioration in value ; product destruction Risk is a Marketing Function (Facilitative function) Risk as Cost; Risk Taking for Profit Farmers Have Unavoidable Price Risk

loader
I am the owner, or an agent authorized to act on behalf of the owner, of the copyrighted work described.
capcha
Download Presentation

PowerPoint Slideshow about 'Price Risk Management and the Futures Market' - blue


An Image/Link below is provided (as is) to download presentation

Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author.While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server.


- - - - - - - - - - - - - - - - - - - - - - - - - - E N D - - - - - - - - - - - - - - - - - - - - - - - - - -
Presentation Transcript
market risk
Market Risk
  • Economic vs. Product Risk
    • product deterioration in value ; product destruction
  • Risk is a Marketing Function (Facilitative function)
  • Risk as Cost; Risk Taking for Profit
  • Farmers Have Unavoidable Price Risk
  • Risk Transfer May Be Desirable, Profitable
examples of your risk management
Examples of Your Risk Management
  • Plant Now, Price Now by Contract
  • College Tuition (Pay in July for Year)
  • College Study (Protect Against Low Pay Job)
  • Magazine Subscription: Pay for copies in advance
  • Home rental contract ; Insurance
grain farmers market risk
Grain Farmers’ Market Risk
  • Plant in Spring Without Knowing Fall Harvest Price
  • Sell in Spring Without Knowing Fall Yield
  • Sell in Fall Without Knowing Spring Price
  • Store in Fall Without Knowing Spring Price
farmer tools for managing price risk
Farmer Tools For ManagingPrice Risk
  • Cash Sale (at Harvest or From Storage)
  • Forward Pricing:
    • Forward Contracts: Cash and Basis contracts
    • Hedging using Futures
    • Options
  • Minimum Price Contract
futures markets
Futures Markets
  • Futures Exchanges : CBOT, CME, KCBT etc.,
  • Futures price is today’s price for products to be delivered in the future.
    • Contract specifications
    • Order execution process (open outcry)
    • Margin requirements
futures market participants
Speculators:

Risk Takers

Profit From Correctly Anticipating Price Changes

Could Not Deliver or Take Delivery of Futures Commodities

Hedgers:

Have Inherent Price Risk

Wish to Reduce or Manage Risk

Could Deliver Against Futures Contract

Futures Market Participants
hedge definitions
Using the Futures or Options Markets To Manage Price Risks

A Temporary Substitution of A Futures Market Transaction for a Planned Cash Market Transaction

Taking Equal and Opposite Positions on the Cash and Futures Markets

Hedge: Definitions
hedging decisions
Hedging Decisions
  • What is my attitude toward price risk?
  • What do I expect price to do?
  • What are my costs?
  • When should I set the hedge? When to lift it?
  • What are my alternatives to hedging?
hedging guidelines
Hedging Guidelines
  • Decide on a definite hedging objective - reasons, month
  • Discuss hedging plan with those involved; e.g. bankers
  • Know how to calculate your productions costs - FC, VC, BEP
  • Follow basis patterns
  • Hedge reasonable amounts of commodity
  • Keep adequate records
production and marketing periods
Production and Marketing Periods

Spring

Planting

Spring/

Summer

Fall

Harvest

Pre-Harvest Period

Storage Period

Risk: Store without

knowing Spring Price

Risk: Plant without

knowing Fall Price

the perfect hedge falling price period
The Perfect Hedge(Falling Price Period)

Cash

Price

Futures

Price

Basis

$.50

Nov. 1

Sell @ $2.50

Buy @ $2.00

Buy @ $2.40

$.50

Dec. 1

Sell @ $1.90

10 cent gain

Cash sale = $1.90

+ Futures Gain = .10

Return to Hedge = $2.00

perfect hedge returns
Perfect Hedge Returns

For a Perfect Hedge (Basis = Constant), The

Return To The Hedge (Cash Price + Futures)

Will Always Be the Same.

slide16

The Perfect Hedge(Rising Price Period)

Cash

Price

Futures

Price

Basis

$.50

Nov. 1

Sell @ $2.50

Buy @ $2.00

Buy @ $2.60

$.50

Dec. 1

Sell @ $2.10

10 cent loss

Cash sale = $2.10

- Futures Loss = .10

Return to Hedge = $2.00

slide17

The Slightly Imperfect Hedge

Cash

Price

Futures

Price

Basis

$.50

Nov. 1

Sell @ $2.50

Buy @ $2.00

Buy @ $2.45

$.55

Dec. 1

Sell @ $1.90

Cash sale = $1.90

$1.95 is better

than $1.90…

But not $2.00

+ Futures Gain = .05

Return to Hedge = $1.95

characteristics of a successful hedge
Characteristics of a SuccessfulHedge
  • Equal and Opposite Positions on Cash and Futures Markets
  • Cash and Futures Markets Move In Same Direction
  • Predictable Basis Pattern
  • Nullify Futures Position, Sell on Cash Market
  • Loss on One Market = Gain on Other Market
  • Transfer of Risk from Hedgers to Speculators
  • No Tears, No Regrets
types of hedges
Types of Hedges
  • Short Hedge (Protects Against Falling Prices)
    • Long Cash, Short Futures
    • Sell Cash, Buy Back Futures
  • Long Hedge (Protects Against Rising Prices)
    • Short Cash, Long Futures
    • Buy Cash, Sell Futures
  • Texas “Hedge” (Not a True Hedge)
    • Same Position on Cash and Futures Markets
    • Doubles the Risk
three farmer hedges
Three Farmer Hedges
  • Perfect Hedge
    • Useful for Learning; Rare in Practice
  • Storage Hedge
    • Set During Storage; Oct. to May
    • Protects Against Falling Prices
    • Helps Earn Storage Returns
  • Pre-Harvest Hedge
    • Set in Spring
    • Protects Fall Harvest Price
storage hedges
Storage Hedges
  • Harvest-to-Sale Period (Storage Season)
  • Risk of Price Decline, Inventory Loss
  • Will Price Rise Cover Storage Costs?
  • Carrying Charges:
    • Storage Costs
    • Handling Charges
    • Insurance and Interest Costs
  • Key to Success: Narrowing Basis Pattern
slide22

The Storage Hedge

Futures

Price

Cash

Price

Basis

Nov. 1

$.50

Buy/Store @ $2.00

Sell @ $2.50

June 1

Sell @ $2.30

Buy @ $2.40

$.10

Cash sale = $2.30

- $.40

+ Futures Gain = .10

=Return to Hedge = $2.40

- Original Cost = $2.00

= Storage Return = $.40

storage hedge rule
Storage Hedge Rule

The Storage Hedger’s Carrying Charge

(Return to Storage) Will Always Equal

The Change in Basis Over the Storage Period

The Storage Hedge Transfers the Basis

Change From the Speculators to Hedgers

hedging principle
Hedging Principle

The Basis Determines

the Success

of A Hedge

corn storage hedge
Corn Storage Hedge

Date Cash Market Futures

Market

October Harvest Price = $3.00 Sell July Fut. = $3.50

Est. June Basis = $.10

Storage Cost = $.30

Forward Price = $3.50-.10= $3.40

Storage Profit= $3.40 -3.00 - .30= $.10

June Cash Sale @ $3.30 Buy Back Fut. @ $3.40

Return to Hedge: $3.30 + $.10 = $ 3.40

pre harvest hedge
Pre-Harvest Hedge
  • Set During Planting or Growing Period
  • Protects Against Harvest Price Risk
    • Will Harvest Price Cover Production Costs?
  • Locks-In Fall Harvest Target Price
  • Key to Success: Requires Accurate Harvest Basis Prediction
slide27

The PreHarvest Hedge

Futures

Price

Cash

Price

Basis

Plant at Target

Price:

$3.00-.40=$2.60

May 1

Planting

Sell @ $3.00

Nov. 1

Harvest

Buy @ $2.80

Expected

$.40

Sell @ $2.40

Cash Sale = $2.40

+ Futures Gain = .20

Return to Hedge = $2.60 = Spring Target

slide28

Corn Pre-Harvest Hedge

Date Cash Market Futures

Market

May Sell Dec Fut. = $2.80

Cost of Production = $2.10

Expected basis = $.30

Forward Price = $2.80-.30 basis= $2.50

Expected Profit= $2.50 -2.10 = $.40

Oct. Cash Sale @ $2.40 Buy Back Fut. @ $2.70

Net Return to Hedge: $2.40 + $.10- $2.10 = $ .40

calculating the return to a hedge
Calculating the ReturnTo a Hedge

Today: Current Futures Price……...$4.00

Less: Expected Basis at Sale Time ….. .50

Equals: Lock-In Forward Price……..$3.50

Future Sale: Cash Price…………………..$3.00

Plus/Minus Futures Transaction……… $.50

Equals: Total Return to Hedge…..…. $3.50

Less: Costs (Prodn. Or Storage)….…$3.20

Equals: Net Return To Hedge……….…..$.30

combination pre harvest and storage hedge
Combination Pre-Harvestand Storage Hedge

Cash Dec. 98 June 99

Market Futures Futures

May 1998 Target $3.00 Sell@$3.40

$3.40-.20 Est. Spr.

= $3.20 basis=$.20

May 1999 $2.30 xxxx Buy@$2.50

Return to Hedge: $2.30 + .90 =$3.20

why don t more farmers hedge
Why Don’t More Farmers Hedge?
  • Lack of Understanding of Hedging
  • Mistrust of Futures Market
  • Prefer Ease of Forward Contracts
  • Like Risk; Prefer to Speculate on Cash Market
  • Dislike Margin Calls
  • Other????
summary risk management tools
Summary: Risk ManagementTools
  • Hedging
  • Options
  • Forward Cash Contracts
  • Basis Contracts
  • Minimum Price Contracts