AECN 235

Speculators are more likely to trade futures contracts than forward contracts. That's because futures contracts are standardized and therefore easy to trade with anybody, futures contracts can be offset before delivery (most speculators don't want to deliver or take delivery because they don't have any business with the physical commodity), and the financial integrity of futures contracts is guaranteed by the clearing house. true or false

true

A commodity can be defined as an economic good that can be legally produced and sold only by selected individuals who own a patent to the product. true or false

False

Futures markets were created to meet specific needs of cash market traders (i.e. producers, grain elevators, grain processors) and should be traded only by these traders. Speculators have no place in futures markets. true or false

False

The basis is determined by all factors that explain the difference between spot and futures prices at any given point in time. true or false

true

commodity you have fewer marketing alternatives

commodity producers cannot set prices or benefit from individual promotion, since there are many other sellers of the same commodity

The basis will be negative as long as the spot price is lower than the futures price. true or false

true

The corn futures contract has 5 delivery months: March, May, July, September and December. Therefore, on any given day in any given cash market, you can calculate one basis for each delivery month. true or false

true

Just like there is a limit to how much corn can be traded in the spot market during a given crop year, there is also a limit to how much grain can be traded in the futures market during the same period. true or false

false

Today I sell corn using one futures contract for December 2019 delivery. If next week I buy corn using one futures contract for March 2020 delivery, then I'll be out of the futures market. true or false

false

Today I sell wheat at $5.70/bu using a futures contract for December 2019 delivery. If, later on, I buy wheat at $5.90/bu using a futures contract for December 2019 delivery, I'll be out of the market with a profit of $0.20/bu. True or false

false

Today I buy wheat for December 2019 delivery in the futures market at $5.50/bu. If later I sell wheat using the December 2019 futures contract at $5.65/bu, I'll be out of the market with a profit of $0.15/bu. true or false

true

We discussed that the basis for storable commodities should reflect the cost of carry, and one of the components of the cost of carry is transportation cost. Since the futures price is based on a specific delivery location, the basis in any given spot market should reflect the transportation cost between that spot market and the futures market's delivery location. Therefore, all else constant, spot markets closer to the futures market's delivery location should have smaller (less negative) basis. true or false

true

When a futures or a forward contract is traded, ownership of the underlying commodity changes hands only when (and if) delivery occurs. true or false

true

In commodity markets it is typically true that:

producers are "price takers".

A producer of a differentiated product has more marketing alternatives because:

producers of differentiated products control the supply of the product, since it is patented, copyrighted or trademarked. it is possible to benefit from promoting it

When grain supply is plentiful, one of the reasons why basis is a large negative number is that sellers (e.g. producers) will likely have to accept lower spot prices if they need to sell immediately (to pay bills, for example). true or false

true

Both forward and futures contracts were created and developed to facilitate trade in the cash market, and not as speculative financial instruments true or false

true

Commodity producers have fewer marketing alternatives because they cannot set prices or benefit from individual promotion, since there are many other sellers of the same product. true or false

true

Forward and futures contracts have the same economic function. true or false

true

Grain buyers (e.g. grain elevators) that are desperate to buy grain now can offer high spot prices to encourage immediate delivery. Alternatively, they can offer a narrow negative basis with the same purpose. true or false

true

If you have a long position in the futures contract for May delivery you can offset it by either going short in the May contract or taking delivery of the underlying product during the delivery period. true or false

true

In a forward contract, if one side (e.g. buyer) defaults the other side (e.g. seller) will lose money. In a futures contract, if one side (e.g. buyer) defaults the clearing house will guarantee that the other side (e.g. seller) will not lose money. True or false

true

In the futures market, all contract terms are standardized. In addition, with the existence of a clearing house, we can say that even traders in futures markets are standardized. true or false

true

On a given day there can be different forward prices for the same commodity, depending on the delivery dates being negotiated. true or false

true

Speculators are more likely to trade futures contracts than forward contracts. That's because futures contracts are standardized and therefore easy to trade with anybody, futures contracts can be offset before delivery (most speculators don't want to deliver or take delivery because they don't have any business with the physical commodity), and the financial integrity of futures contracs is guaranteed by the clearing house. true or false

true

When there is shortage of grain in the market, one of the reasons why basis is a small negative (or even positive) number is that buyers are willing to offer higher spot prices if they need to buy grain immediately. True or false

true

differentiated product you have more marketing alternatives

you control the supply of the product you can price your product and earn benefits from promoting it still, at the end of the day, it all depends on whether or not consumers perceive your product to be worth the price

Commodities

"economic good that can be legally produced and sold by almost anyone" Commodities cannot be differentiated across their producers

n commodity markets, we often hear that "Big crops, large stocks, lower prices and wider spreads between futures prices walk together. Similarly, smaller crops, small stocks, higher prices and narrower spreads between futures prices walk together." (a) Based on questions 1 and 2, explain whether you agree or disagree with the idea that big crops and large stocks are associated with lower prices and wider spreads between futures prices. (b) Based on questions 1 and 2, explain whether you agree or disagree with the idea that small crops and small stocks are associated with higher prices and narrower spreads between futures prices.

(a) I agree with the statement. As the USDA estimates larger and larger numbers for production and stocks, futures prices start falling in face of the expected increase in supply of grain in the market (more supply, lower prices). This is what we see as the futures prices in 2018 drops from around $4.30/bu in May to around $3.80/bu in November. At the same time, the estimated increasing supply of grain leads the futures market to incentivize producers to store grain and deliver in later months (e.g. July 2019) instead of delivering right after harvest (e.g. December 2018). This incentive for storage can be seen in the widening spread between the futures prices for July 2019 delivery and December 2018 delivery (question 1), offering producers a relatively higher price to delivery in July 2019 instead of December 2018. (b) I agree with the statement. If forecasts for production and stocks are decreasing (i.e. if the USDA is estimating smaller supply of grain in the market), overall we would see futures prices increasing because of the expected reduction in supply (less supply, higher prices). This is what we see as the futures prices in 2012 rise from $5/bu in May to $8/bu in November. In this scenario of limited supply, we would also expect the futures market to provide incentives for immediate delivery and not for storage. Hence, the spread between the futures price for July 2013 delivery and the futures price for December 2012 delivery should narrow and even become negative, which would reduce the incentive for storage and encourage producers to deliver right after harvest. Again, this is what we see in the charts for 2012.

What are the main characteristics of a commodity market?

(a) The product is homogeneous, i.e. the product is the same regardless who produces it. (b) Since all producers produce the exact same product, producers can't benefit from promoting or advertising their product. In the same line, commodities can't be patented, copyrighted or trademarked. (c) Since there are no patents, copyrights or trademarks for commodities, these markets are typically easy to entry. In other words, once a producer has the knowledge and resources, he/she can easily start producing the commodity and participate in the market. (d) There are many producers. (e) Given the homogeneity of the product (commodity) and the large number of producers, no individual producer can affect the market price. Hence, commodity producers cannot "make" the price in the market (they are "price-takers").

A producer is considering selling her corn with either a forward or a futures contract. Recalling that the corn futures contract size is 5,000 bushels and delivery months are March, May, July, September and December, which statement(s) below is (are) correct? 1. Both contracts allow future delivery at the price traded in the contract. 2. With the forward contract she can sell whatever quantity she negotiates with the buyer, while with the futures contract she can only sell in multiples of 5,000 bushels. 3. Whatever contract she chooses, the only possible delivery months are March, May, July, September and December 4. Regardless the contract she chooses, she can deliver wherever she negotiates with the buyer.

1.Both contracts allow future delivery at the price traded in the contract. 2.With the forward contract she can sell whatever quantity she negotiates with the buyer, while with the futures contract she can only sell in multiples of 5,000 bushels.

You can find below some statements about futures prices. Which one(s) is(are) correct? 1.Futures prices represent the expected spot price at the delivery area during the delivery period in the future. 2.If you sell a commodity using futures contracts, the futures price that you traded is the price you will receive when you deliver your commodity against the futures market. 3.Futures prices for different delivery months can refer to different delivery areas across the country. 4. Since futures prices reflect the 'expected' spot price in the delivery area during the delivery period in the future, they vary over time as 'expectations' change.

1.Futures prices represent the expected spot price at the delivery area during the delivery period in the future. 2.If you sell a commodity using futures contracts, the futures price that you traded is the price you will receive when you deliver your commodity against the futures market. 4. Since futures prices reflect the 'expected' spot price in the delivery area during the delivery period in the future, they vary over time as 'expectations' change.

You can find below some statements about futures prices. Which one(s) is(are) correct? 1.Futures prices represent the expected spot price at the delivery area during the delivery period in the future. 2.If you sell a commodity using futures contracts, the futures price that you traded is the price you will receive when you deliver your commodity against the futures market. 3.Futures prices for different delivery months can refer to different delivery areas across the country. 4.Since futures prices reflect the 'expected' spot price in the delivery area during the delivery period in the future, they vary over time as 'expectations' change.

1.Futures prices represent the expected spot price at the delivery area during the delivery period in the future. 2.If you sell a commodity using futures contracts, the futures price that you traded is the price you will receive when you deliver your commodity against the futures market. 4.Since futures prices reflect the 'expected' spot price in the delivery area during the delivery period in the future, they vary over time as 'expectations' change.

Since commodities such as corn and soybeans are produced only once a year, it could happen that producers would sell their entire production at once by harvest. However, these commodities can be stored, which allows producers to either sell at harvest or store to sell later. Based on this idea, which statement(s) is(are) true? 1.If all producers sell their entire crops at harvest there will be two undesirable consequences: harvest prices would be severely depressed and there would be a shortage of the commodity after harvest. 2.Storage is an important marketing function as it allows producers to spread their sales out over the year, and hence consumption to be spread out over the year too. 3.The ability to store also means that commodity producers have another marketing dimension to consider, i.e. whether they should sell at harvest or wait to sell at a later date. 4.In order to guarantee that at least some commodities will be stored, society needs to offer incentives for storage, which typically come in the form of higher prices after harvest.

1.If all producers sell their entire crops at harvest there will be two undesirable consequences: harvest prices would be severely depressed and there would be a shortage of the commodity after harvest. 2.Storage is an important marketing function as it allows producers to spread their sales out over the year, and hence consumption to be spread out over the year too. 3.The ability to store also means that commodity producers have another marketing dimension to consider, i.e. whether they should sell at harvest or wait to sell at a later date. 4.In order to guarantee that at least some commodities will be stored, society needs to offer incentives for storage, which typically come in the form of higher prices after harvest.

Today a grain producer in Nebraska wants to sell 20,000 bushels of corn for delivery in the fall. She is considering a forward contract with her local grain elevator or a futures contract. In the corn futures market, contract size is 5,000 bu; delivery months are March, May, July, September and December; and delivery location is in northern Illinois. Based on this information, which statement(s) below is(are) true? 1. If she chooses to use a forward contract with her local grain elevator, she can sell all 20,000 bu in one contract and deliver in whatever month they agree on. 2.If she chooses to use a futures contract, she will need to trade 4 contracts and can only deliver in September or December (if she wants to do it in the fall). 3.In terms of delivery, the forward contract has the advantage of "local delivery", while with the futures contract she would need to go to northern Illinois to deliver. 4.Even if she chooses the futures contract now, she can easily offset the futures contract later (before delivery) and still sell her grain to the local elevator in the fall. 5. Regardless her choice, she needs to have funds to deposit an initial margin when she starts the contract and perhaps cover margin calls while the contract is open.

1.If she chooses to use a forward contract with her local grain elevator, she can sell all 20,000 bu in one contract and deliver in whatever month they agree on. 2.If she chooses to use a futures contract, she will need to trade 4 contracts and can only deliver in September or December (if she wants to do it in the fall). 3.In terms of delivery, the forward contract has the advantage of "local delivery", while with the futures contract she would need to go to northern Illinois to deliver. 4.Even if she chooses the futures contract now, she can easily offset the futures contract later (before delivery) and still sell her grain to the local elevator in the fall.

Basis tends to be more negative when grain supply is large because: (mark all that apply) 1.Large quantity of grain in the market creates more demand for storage, which leads to higher price for storage and thus higher cost of carry. 2.The convenience yield will be a large number due to the huge amount of grain available in the market. 3.Grain buyers will likely not be desperate to buy grain, hence they won't be willing to offer higher spot prices. 4.Transportation cost should be very low in a market full of grain.

1.Large quantity of grain in the market creates more demand for storage, which leads to higher price for storage and thus higher cost of carry. 3.Grain buyers will likely not be desperate to buy grain, hence they won't be willing to offer higher spot prices.

Basis tends to be less negative (or even positive) when grain supply is limited because: (mark all that apply) 1.Small quantity of grain in the market creates less demand for transportation, which leads to lower price for transportation and thus lower transportation cost. 2. The convenience yield will be a large number due to the limited amount of grain available in the market. 3.Grain buyers will likely not be desperate to buy grain, hence they won't be willing to offer higher spot prices. 4. Storage cost should be relatively low when there is shotage of grain.

1.Small quantity of grain in the market creates less demand for transportation, which leads to lower price for transportation and thus lower transportation cost. 2. The convenience yield will be a large number due to the limited amount of grain available in the market. 4. Storage cost should be relatively low when there is shotage of grain.

oday the corn futures market is trading at: $3.90/bu for May 2019 delivery $3.98/bu for July 2019 delivery $4.02/bu for September 2019 delivery If the corn spot price in a certain location is $3.60/bu today, we can say that (mark all that apply): 1.The basis for May in that spot market is -$0.30/bu. 2.the basis for July in that spot market is -$0.32/bu. 3.The basis for September in that spot market is -$0.42/bu. 4.In general, in any given spot market, there will be a basis for each delivery month of the futures market.

1.The basis for May in that spot market is -$0.30/bu. 3.The basis for September in that spot market is -$0.42/bu. 4.In general, in any given spot market, there will be a basis for each delivery month of the futures market.

What statement(s) below is(are) correct? 1. Research evidence shows that marketing is irrelevant to explain profitability in farming operations. 2. Research evidence indicates that differences in marketing performance help explain differences in the profitability of farming operations. 3. A recent experiment at the UNL suggests that profitability in farming operations is driven by a well-balanced combination of production efficiency and marketing.

2. Research evidence indicates that differences in marketing performance help explain differences in profitability of farming operations. 3. A recent experiment at the UNL suggests that profitability in farming operations is driven by a well-balanced combination of production efficiency and marketing.

Today the corn basis for December is -$0.40/bu in a certain cash market. Based on this information, you can say that: (mark all that apply) 1.The local spot price is above the futures price for December delivery. 2.If the cost of carry between today and December decreases next week, we should expect the basis to become less negative. 3.The difference between the local spot price and the December futures price is $0.40/bu. 4.There is no way to figure out the cost of carry between today and December.

2.If the cost of carry between today and December decreases next week, we should expect the basis to become less negative. 3.The difference between the local spot price and the December futures price is $0.40/bu.

A soybean producer has some grain stored and is considering selling it now. His local grain elevator is offering to pay $9.13/bu now, or $9.03/bu if the producer prefers to sell in November. In this case: (only one is correct) 1.The producer should figure out the storage cost between today and November before making any decision. 2.The producer doesn't need to know the storage cost, because the price offered for November is already lower than the price offered for immediate delivery. 3. The producer should sell now only if the storage cost between today and November is smaller than $1.00/bu. 4.As of today, there is a clear incentive for the producer to keep storing the grain.

2.The producer doesn't need to know the storage cost, because the price offered for November is already lower than the price offered for immediate delivery.

A corn producer has some grain in storage and is considering whether she should sell it now or hold it a while longer. Her local grain elevator is offering $3.29/bu to buy it today, $3.42/bu to buy it in April (3 months ahead), $3.53/bu to buy it in July (6 months ahead) and $3.58/bu to buy it in October (9 months ahead). The producer calculates storage costs and learns that it will cost her $0.03/bu/month to store corn. Based only on this information, the producer should sell her corn: (only one is correct) 1. today, for immediate delivery, and receive $3.29/bu. 2.for April, and receive $3.42/bu minus storage costs. 3.for July, and receive $3.53/bu minus storage costs. 4.for October, and receive $3.58/bu minus storage costs.

3.for July, and receive $3.53/bu minus storage costs.

Commodities such as corn and soybeans are produced once a year, but can be stored for several months. Therefore, a corn or soybean producer can have grain stored by the time she is making plans for the next harvest. In this case, we can say that: (check all that apply) 1.she would focus only on current market prices to decide whether to sell now or keep storing the grain she currently has on storage. 2.she should focus only at storage costs to decide whether to sell now or keep storing the grain she currently has on storage. 3.she should look at current market prices, storage costs and expected prices before making a decision on whether to sell now or keep storing the grain she currently has on storage.

3.she should look at current market prices, storage costs and expected prices before making a decision on whether to sell now or keep storing the grain she currently has on storage.

What is the main difference between a spot price and a forward price? At any point in time, how many spot and forward prices do we have in a given marketplace (for example, Lincoln, NE)?

A spot price is the price negotiated between a buyer and a seller for immediate delivery. Once they agree on a price, ownership of the commodity is exchanged immediately, along with payment. Since this transaction calls for delivery and payment "today", there is only one spot price. A forward price is the price negotiated between a buyer and a seller for future delivery. In this case, buyer and seller agree on a price and on a date in the future when delivery will happen. Thus, ownership of the commodity and payment are only exchanged on the delivery date in the future. Since there are many possible delivery days in the future, there will be different forward prices for different delivery dates in the future. For example, today in Lincoln, NE, there is a spot price if a buyer and a seller agree on immediate delivery of the commodity, and there are many forward prices (one for each delivery date in the future) if they agree on future delivery of the commodity.

Are speculators important to futures markets? Why?

Answer: Speculators are important to futures markets as they provide liquidity and help with price discovery. The more traders there are in the futures market, the easier it is to find somebody to take the other side of your contract and execute the trade. In particular, a futures market with lots of trades (speculators) makes it easier for hedgers to make their trades. Further, a large number of traders in the market implies that there are many people trading and analyzing information on supply and demand to figure out the "true" price of the commodity, which helps with the price discovery process.

Why should commodity producers pay attention to storage costs? Provide a numerical example to illustrate your answer.

Commodity producers can sell for immediate delivery (spot transactions) or for future delivery (forward transactions). If they choose to sell for future delivery, they will need to store the commodity until it is time to delivery. This means that they will incur storage costs, which will be discounted from their price. Let's say that a food processor offers a corn producer a spot price of $3.30/bu (immediate delivery) and a forward price for May delivery of $3.40/bu (forward price). In other words, the producer can choose to deliver her grain right away and receive $3.30/bu (spot price), or store her grain and deliver in May for $3.40/bu (forward price for May). Assuming that storage cost is $0.12/bu between today and May, this producer would have an extra cost of $0.12/bu if she decides to store the grain and wait until May to deliver. In this case, she would end up with a final price of $3.28/bu (contracted price of $3.40/bu minus $0.12/bu of storage cost). Therefore, the forward price for May delivery ($3.40/bu) appears to be higher than the spot price for immediate delivery ($3.30/bu). But after taking into account storage cost, the spot price turns out to be a better option.

How does marketing commodities (such as corn or soybeans) differ from marketing food products (such as pasta or other types of processed food)?

Commodity producers do not control the market supply of their product, i.e. no individual producer can affect the market price of the commodity. Producers of differentiated products, on the other hand, produce an unique product (or, at least, consumers believe so) and hence they control the whole market supply. Since commodity producers don't control the market supply and cannot individually affect the the market price, they have to "take" the price that is being traded in the market when they want to sell their commodity. In other words, commodity producers don't "make" the price in the market. Keep in mind that, just because commodity producers are "price-takers", it doesn't mean that they have to passively accept whatever price buyers offer to them. Commodity producers can (and should) have a marketing plan that allows them to use different tools (contracts) and sell at different times of the year in order to take advantage of profitable opportunities in the market. Besides, depending on business relationships and the nature of the transaction, commodity producers may be able to negotiate better prices with the buyers.

The chart below shows the average corn basis in 2013-2016 for a particular grain elevator in Lincoln during the calendar year (week 1 = first week of January, week 5 = first week of February, week 25 = first week of June, week 40 = first week of September, and so on). basis.jpg In general, what factors could explain these changes in basis during the year?

Going back to our class discussions, let's think about the three factors that affect the basis: cost of carry, transportation cost, and local supply and demand conditions. Overall, cost of carry and transportation cost depend on the availability of grain in the market. When there is plenty of grain in the market, there will be more demand for storage and transportation, hence the cost of carry and transportation cost will be larger, and then the basis will be wider. On the other hand, when there is a shortage of grain in the market, there will be less demand for storage and transportation, hence the cost of carry and transportation cost will be smaller, and then the basis will be narrower. Corn is harvested in the Fall, approximately around week 40 in the chart. At that point, we typically have more supply of grain in the market and hence the basis tends to be wider. As we get to the winter and spring (weeks 1 through 15-20 in the chart), some grain has been consumed and/or exported, so the availability of grain is not as large as it was in the fall. Therefore, the basis starts to become narrower. Finally, in the summer and then just before the next harvest, there is usually not much grain around, which makes the basis even narrower. Now, the other factor is supply and demand conditions in local markets. If a given grain elevator, at some point in the year, is desperate to buy grain, they will be willing to offer a narrower basis in order to encourage producers to sell. However, if the grain elevator doesn't need to buy grain, they will likely offer wider basis in order to discourage producers to sell. This factor, together with the cost of carry and transportation cost, explains how the basis varies during the year.

We discussed that producers of differentiated products are considered "price-makers". What exactly does it mean to be a "price-maker"? Does it imply that a company that is price-maker can set whatever price it wants for its product? Why?

If I produce a differentiated product and hence I am the only producer of this unique product, I control the whole supply of the product in the market. This gives me a lot of power to determine the market price of my product, but not full power to do so. The market price is determined by supply and demand. Even though I control the market supply, the actual price in the market still depends on the demand. If I try to set a very high price, consumers will choose not to purchase the product and I will have t set a lower price in order to sell my product. Therefore, price-makers have a lot of power in setting the market price of their product, but they don't have enough power to set any price that they like.

On September 2, 2016 there were 629,059 open contracts in the soybean futures market in Chicago. Since each contract corresponds to 5,000 bushels, more than 3 billion bushels of soybeans are committed to change hands in the futures market at the expiration of those contracts. The United States Department of Agriculture (USDA) was then forecasting that soybean production in the U.S. in 2016/17 would amount to approximately 4 billion bushels. Did it mean that about 75% of the U.S. soybean production (3 billion out of 4 billion bushels) would be delivered against the futures market? Explain your answer.

If those contracts remained open until delivery, and the sellers went ahead and actually delivered in the futures market, then it would mean that about 75% of the U.S. soybean production was delivered in the futures market. However, in reality, very few futures contracts actually go to delivery. Most of them are offset before delivery. For example, remember that speculators trade a large amount of futures contracts and they never want to go to delivery, so they will get out of the futures market before delivery happens. Since it is easy to get in and out of futures contracts, buyers and sellers can trade large amounts of soybeans in the futures market without having any intention to actually deliver or take delivery in the futures market.

What are the two characteristics of futures markets that make them attractive to speculators? Explain your answer.

It is easy to get in and out (offset) futures contracts. All contract specifications are the same for all traders. Since all traders are trading "the same product", it is easier to find somebody to trade with. Since speculators have no interest in the physical commodity, they want the ability to get out of their commitment (futures contract) before delivery happens. Hence it is important to speculators that it is easy to offset a futures contract by taking the opposite position in the market. Leverage. Futures contracts allow traders to speculate on commodity prices, and possibly make large profits, with a relatively small initial investment.

Commodity producers are considered to be "price-takers", which implies that:

No single producer can individually control the market supply.

Discuss the similarities and difference s between a forward contract and futures contract.

Please check the handout "comparison between forward and futures contracts" (Module 2 in Canvas). Future: Nature of transaction: Buyer and seller agree to buy or sell a standardized amount of a standardized quality of a commodity at a set price at a future date. Size of contract,delivery date: Standardized. pricing: Prices are determined publicly in open, competitive, auction-type market at a registered exchange. Prices are continuously made public. Security deposit :Both buyer and seller post a performance bond (funds) with the exchange. Daily price changes may require one party to post additional funds and allow the other party to withdraw such funds Forwards Buyer and seller make a customtailored agreement to buy/sell a given amount of a commodity at a set price at a future date. Negotiable.

Why is it more common to see speculators trading futures contracts than forward contracts?

Speculators have no interest in the physical commodity, i.e. they don't want to deliver or take delivery of the commodity. Hence, they need to be able to get out of their contracts before delivery day. Forward contracts are highly customized, thus it is harder to find other people willing to take that contract with unique specifications. On the other hand, futures contracts are standardized, i.e. all specifications are the same. Therefore, it is easier to find people willing to take on those contracts. Since it is easier to trade and re-trade futures contracts (and therefore get in and out of futures contracts), speculators prefer to trade futures contracts instead of forward contracts.

How does the clearing house help facilitate trade in futures markets?

The clearing house stands between every buyer and seller in the futures market, working to (i) match all transactions in the futures market, (ii) guarantee that all contracts will be honored, and (iii) providing the necessary mechanisms/structure for delivery. As the clearing house takes the opposite side of every trade in the futures market, it becomes the seller to every buyer and the buyer to every seller. Therefore, in practice, it is the clearing house is on the other side of every contracts in the futures market. If the seller wants to deliver, the clearing house guarantees that he will be able to deliver. If the byer wants to take delivery, the clearing house guarantees that he will receive the quantity of the commodity that he contracted. If the seller or buyer offsets his futures contract at a gain, the clearing house guarantees that he will receive the amount of money he is due. The main job of the clearing house is to reduce the risk of defaults, guaranteeing that all futures contracts will be honored. In other words, it guarantees the financial integrity of the futures market.

Discuss the following statement: "Marketing is not important when prices are high and/or rising, because then it is very easy to make a profit."

There are different ways to discuss this statement. The point that I will make is that marketing is still very important when prices are high and/or rising, because in those times we have the opportunity to obtain extra profits that will be useful to keep our business (i.e. farming operation) running or even to expand our business. Prices are not high every year, so there will always be years when it will be hard to guarantee a profit, just like there will be years when we will lose money. When those years come around, having extra funds is important to keep our farm operation running. Those extra funds can be obtained during years when price are high, and this is why marketing is important in times of high prices as well (remember that, when we are running a business, we can't afford to leave money on the table).

You have just sold 30,000 bushels of corn in the futures market for delivery in December, which means that you have just made a commitment to deliver 30,000 bushels of corn to a certified warehouse in the delivery region of the futures market in December. What are your options to get rid of this commitment (futures contract)?

There are three options to get rid of your futures contracts, but we only discussed two of them in class. So let's just focus on these two options here. One option is simply to go ahead and deliver 30,000 bushels of corn to a certified warehouse in the delivery region of the futures market in December. Note that it has to be to a certified warehouse in that specific delivery location. You can't choose any warehouse in any location that you like. Once delivery is completed, you fulfill your contract and have no further commitment in the futures market. The other option is to take the opposite position in the futures market before delivery. Since you initially sold 30,000 bushels for December delivery, you can now buy 30,000 bushels for December delivery. Then you will have a commitment to deliver 30,000 bushels (short contract) and another commitment to take delivery of 30,000 bushels (long contract). In the eyes of the futures exchange, it is as if you are delivering 30,000 bushels to yourself and nobody else needs to get involved. Since you are delivering all those bushels to yourself, you don't need anybody else and you are out of the futures market. In this situation, the futures exchange simply offsets your contracts and you have no further commitment in the futures market.

Discuss the statement below and explain why you agree or disagree with it. Provide a numerical example to illustrate your answer. "In futures markets, there is always the same number of long contracts and short contracts, which means that the number of buyers must also be the same as the number of sellers."

This statement is partially correct. For each futures contract, there is a buyer (long) and a seller (short). If 100 futures contracts are traded, there will be 100 people in the long side and 100 people in the short side. However, those 100 people don't have to be 100 different people. For example, let's say that 1 person bought 100 futures contracts, and 100 different persons sold 1 futures contracts each. In this case, there will be 1 trader on the long side of the market (buyer) holding 100 contracts, and 100 traders on the short side of the market (sellers) holding 100 contracts altogether. Hence, the number of long and short contracts is the same, but the number of buyers and sellers is different.

Do you agree with the statement below? Why? Provide examples to illustrate why you agree or disagree with this statement. "Forward contracts and then futures contracts were created to help facilitate trade in commodity markets. They were developed to fulfill specific needs from buyers and sellers in the market."

Yes, I agree with this statement. Contracts for future delivery were created by commodity buyers and sellers in order to facilitate trading. Initially, commodities were traded only for immediate delivery (spot transactions). For grains, for example, that meant that producers would harvest their grain once a year and try to sell everything as fast as they could. This implied that there would be large amounts of grain being sold at harvest, which would make prices lower and reduce producers' returns. Further, grain buyers needed to buy all the grain they need for the whole year right after harvest, which created more problems: they needed to have large storage capacity to hold all that grain for several months, and they also needed large amounts to money to pay for all that grain at once. Then buyers and sellers came up with an idea that revolutionized grain trading: trading for future delivery. They created "forward contracts", which allowed buyers and sellers to trade today but only exchange ownership of the commodity at a certain date in the future (payment would also be exchanged on delivery day). Buyers and sellers would then make a commitment to each other to exchange a given commodity at a given price on a given day in the future. This made it easier for them to plan ahead, and helped solve their previous problems: producers and buyers no longer needed to sell/buy everything they needed right after harvest, storage could be better distributed between buyers and sellers, and buyers didn't need to have enough money to buy all the grain they needed at harvest. However, these forward contracts were highly customized, i.e. the specifications of the contracts (quantity traded, delivery location, delivery date, etc) could be whatever buyer and seller agreed on. As time went on, they realized that there would be many occasions in which buyers and/or sellers would like to get out of their forward contracts. Maybe they found a better deal with another trader, or a producer realized that he wouldn't have enough grain to deliver, or the buyer realized that he wouldn't need all the grain that was contracted, and son on. Since forward contracts are legally-binding agreements, they couldn't simply walk away from it. They had to find somebody else willing to take their side of the contract. But since forward contracts were so customized, it was hard to find another person who wanted a deal with the exact same specifications, which made it harder to trade and re-trade forward contracts. That's when grain traders had another idea the revolutionized commodity markets: futures contracts. Futures contracts are essentially "standardized forward contracts". They are contracts for future delivery in which all specifications are the same. Every futures contract for a given commodity calls for the same quantity being traded and has the same delivery date, same delivery location, etc. If a buyer or seller holding a futures contract decides to get rid of it, it is easy to find somebody else to take the contract because everybody is trading the exact same contract. With futures contracts, it became easier to trade and re-trade grain, which facilitate the expansion of grain trading.

Many speculators trade in futures markets, even though they have no interest in the underlying physical commodities. Do you think it is important to have speculators in futures markets? Why?

Yes, speculators are important in futures markets. They have no interest in the physical commodity and trade in the futures market trying to make a profit from buying and selling commodities ("buy low, sell high"). Since they have no interest in the physical commodity, they can buy and sell as many contracts as they like. They are not going to delivery or take delivery, so it doesn't matter if they trade 5,000 bushels or 1,000,000 bushels. No matter how many contracts they trade, they can easily get out of the futures market before delivery and get rid of any commitment to deliver or take delivery of the commodity. As speculators are always in the market and can trade as many contracts as they like, they provide liquidity to the futures markets. When hedgers (e.g. producers or food processors) want to buy or sell in the futures market, they can easily find a speculator willing to take the other side of their contracts. Similarly, when they want to get out of the futures market, they can also easily find a speculator to take the other side of their contracts and help them offset their positions.

If today the corn basis is -$0.40/bu in your local cash market, you know that your local spot price today is $0.40/bu higher than the futures price. true or false

false

In a cash market all transactions are for immediate delivery. true or false

false

differentiated product

economic good that belongs to a single seller and that often may be patented, copyrighted, or trademarked to the exclusive use of that seller

Basis is a single number that holds for different regions and different delivery dates. true or false

false

Both forward and futures contracts can be easily offset in the same way. true or false

false

Both futures and forward contracts are highly standardized. Hedgers and speculators have no flexibility in changing some specifications of the neither of these contracts. true or false

false