Supply and Demand Chaos

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					Supply and Demand
      Chaos
  Early Markets in the
          US
     Exchanges
• Chicago Board of Trade
• Chicago Mercantile
  Exchange
• Commodity Exchange
  Incorporated
    Exchanges
• Kansas City Board of
  Trade
• New York Cocoa
  Exchange
 Characteristics of
Commodities Traded
• Units homogeneous
• Susceptible to grading
  and standardization
• Supply and demand
  uncertain
   Characteristics of
  Commodities Traded
• Large supply and demand
• Supply flows naturally to
  market
• Commodity not very
  perishable
     What is a futures
       contract?
• A transferable agreement
  to make or take delivery of
  a standardized amount of
  a commodity of minimum
  quality during a specific
  month.
Terms of a Contract
   • Commodity
   • Price
   • Quantity
   • Quality
Terms of a Contract
 • Time of delivery
 • Place of delivery
 • Terms of payment
   Settlement of a
  futures contract
• Delivery
• Offsetting transaction
  Concept of
Long and Short

 • Long - Buy
 • Short - Sell
      Open Interest
• 1 long position + 1 short
  position = 1 open contract
    E.g.: Open Interest
•   A sells to B
•   A-short; B-long
•   C sells to B
•   A-short; B-long 2; C-short
•   Open interest = ?
•   Open interest = 2
    Margin Monies
• Secure position of trader
• Solvency of Clearing
  House
    Margin Example
• Soybean contract (5000
  bu)
• Original margin = $3,000
• Call point = $2,000
   Margin Example
• Sold soybeans @ $6
• Then price increases to
  $6.25
• Would you get a margin
  call?
     Margin Example
• Calculate the Trading
  Result (TR)
• TR = (value of contract
  sold) - (value of contract
  that must be bought back)
    Margin Example
• TR = (5000 x $6) - (5000 x
  $6.25)
• TR = $30,000 - $31,250 =
  -$1,250
    Margin Example
• Effective Margin = Original
  Margin +/- Trading Result
• EM = $3,000 - $1,250 =
  $1,750
Speculation vs.
   Hedging
  What is speculation?
• Taking a position in the
  market in order to make
  money on the rise and fall
  of futures prices of certain
  commodities.
      Speculation
• Buy a contract at a low
  price, then turn around
  and sell the contract at a
  high price.
• Buy low, sell high.
      Speculation
• Sell a contract at a high
  price, then turn around
  and buy the contract at a
  low price.
• Sell high, buy low.
 Speculator’s Role
• Provides risk capital
• Provides volume and
  liquidity
• Keeps some markets in
  alignment through
  arbitrage
     What is hedging?
• Taking an equal and opposite
  position in the futures market
  to that in the cash market in
  order to insulate one’s
  business against price level
  speculation.
      Why hedge?
• Too much price risk
• Highly leveraged
• Some banks require it as
  part of a loan agreement
  Causes of Price Risk
• Time difference between
  production and marketing
• Uncertain nature of farm
  production
• National or international
  policies
The Producer’s
    Hedge
 The Producer’s Hedge
• Date Cash • Futures
  Mar. 1: Est. Sell: Dec.
  Price $2.60  futures @ $3
  Nov. 1:      Buy: Dec.
  Harvest &    futures @
  sell @ $2.40 $2.80
 The Producer’s Hedge
• Date Cash        • Futures
  3/1:   $2.60      Sell: $3
  11/1: Sell $2.40 Buy: $2.80

        -$0.20        +$.020
 The Producer’s Hedge
• The producer sold crop at
  $2.40 in the market at
  harvest.
• Bought back the futures
  contract for $2.80.
 The Producer’s Hedge
• The producer gained
  $0.20 in the futures
  market to add to earnings
  in the cash market.
The Producer’s Hedge
• Nov. 1 cash price = $2.40
  + futures gain =    $0.20
  Total return =      $2.60

• Note: Estimated return =
  $2.60
The Processor’s
    Hedge
The Processor’s Hedge
• Date Cash • Futures
  Mar. 1: Lock Buy: Mar. @
  in $5.40     $5.70
  Nov. 1: Buy  Sell: Mar. @
  @ $7.00      $7.30
The Processor’s Hedge
• Date Cash      • Futures
  3/1:   $5.40    Buy: $5.70
  11/1: Buy $7.00 Sell: $7.30

                      +$1.60
The Processor’s Hedge
• Processor bought grain for
  $7 in cash market.
• Sold futures contract for
  $7.30.
• Gained $1.60 in the futures
  market to help cover cost of
  grain purchased.
The Processor’s Hedge
• Nov. 1 cash price = $7.00
  + futures gain =   -$1.60
  Net cost =          $5.40

• Note: Estimated price =
  $5.40

				
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posted:8/31/2012
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