Chapter 2 Beginning with the Basics
Chapter 2 Beginning with the Basics
Why do we need the futures market? Suppose that you and I lived in rural area.I raise beef cattle.You raise corn 15 miles down the road
◼ Suppose that you and I lived in rural area. I raise beef cattle. You raise corn 15 miles down the road. Why do we need the futures market?
■ Each fall,when your corn comes in,you truck the entire crop to me,and I buy it to feed to my steers. To make things fair,we agree that I will pay you the cash price for corn on an exchange on the day I take delivery
◼ Each fall, when your corn comes in, you truck the entire crop to me, and I buy it to feed to my steers. ◼ To make things fair, we agree that I will pay you the cash price for corn on an exchange on the day I take delivery
Corn is important to both of us.It is your principal crop;it is my main cost in feeding cattle
◼ Corn is important to both of us. It is your principal crop; it is my main cost in feeding cattle
Let's set our corn price now for next fall Let's pick a price that allows each of us a reasonable profit and agree on it
◼ Let’s set our corn price now for next fall ◼ Let’s pick a price that allows each of us a reasonable profit and agree on it
Definition of a futures contract A futures contract is an agreement between a seller and a buyer.The agreement calls for a seller to deliver a specified quantity of a particular grade of a certain commodity or its cash equivalent to a predetermined location on a certain date
Definition of a futures contract ◼ A futures contract is an agreement between a seller and a buyer. The agreement calls for a seller to deliver a specified quantity of a particular grade of a certain commodity or its cash equivalent to a predetermined location on a certain date
What is Risk Transfer and Why transfer it? Ask any farmer about the risks involved in growing a crop of corn
What is Risk Transfer and Why transfer it? ◼ Ask any farmer about the risks involved in growing a crop of corn
What is Risk Transfer and Why transfer it? If the weather during the growing season is too dry or too wet or too windy,the farmer may have a poor crop,but so will other farmers
What is Risk Transfer and Why transfer it? ◼ If the weather during the growing season is too dry or too wet or too windy, the farmer may have a poor crop, but so will other farmers
Who Benefits from the Transfer of Risk? The transfer of risk using a futures contract can benefit the buyers,or the seller,or both
Who Benefits from the Transfer of Risk? ◼ The transfer of risk using a futures contract can benefit the buyers, or the seller, or both
Who Benefits from the Transfer of Risk? The trader who took the other side of the corn transaction is unhappy to be losing $1 on the trade. The risk in this case has been transferred from the producer (seller)to the buyer
Who Benefits from the Transfer of Risk? ◼ The trader who took the other side of the corn transaction is unhappy to be losing $1 on the trade. ◼ The risk in this case has been transferred from the producer (seller) to the buyer