Exam 2 agec 314 weber

what issues does a price support create

A price support above the equilibrium price leads to a surplus. The deadweight loss of price supports involves the usual deadweight loss plus the entire cost of unconsumed goods.

motivations to contract

Allocation of value: how the share of the value of the commodity or product being produced is allocated Allocation of decision rights: provisions of the contract that require the grower to follow a certain protocol Allocation of risk: establishes who bears the costs should something go wrong

Hog/pork

Another case of homogenous demand and alterable supplies. Primarily yield grades used for transactions between producers and packers and related market news reports

Basis Formula

Basis = Cash Price - Futures Price

weakening

Becomes less positive Hurts a short hedger Helps a long hedger

strengthening

Becomes more positive Hurts a long hedger helps a short hedger

Beef cattle

Beef is characterized by homogeneous demand and alterable supplies Beef grades now have a dual character - Yield and Quality grades. Yield grades: the classification of beef carcasses according to their leanness and their percentage yield of trimmed retail cuts Numbered 1 through 5 for cattle USDA prime- highest quality and high marbling USDA choice-great quality, moderate marbling USDA select-good quality, slight marbling

why does hedging often work?

Cash and futures prices can be volatile, but they move close enough in the same direction to allow for effective use of futures as a price insurance tool.

Hedging hazards

Changing basis Failure to distinguish between hedging and speculating Hedging too early in rising markets or too late in declining markets Inadequate liquidity to finance margin calls Production shortfalls

Motivations for vertical integration

Control prices and quality

Advantages of Decentralized, individual negotiation

Convenience and lower transaction costs Seller has more control

hedging

DEFINITION - USING FUTURES TO MANAGE (REDUCE) PRICE RISK An effort to lock in a price now (instead of waiting until you are ready to buy/sell the product)An effort to protect yourself (as a buyer or seller)

Homogenous Demand

Demand for quality is defined as homogeneous demand when buyers agree on the ordinal relationships of the various qualities of a commodity.

Grain

Demand is generally homogenous. The grade of a shipment may decline by one or more grades during shipment overseas because of the increase in broken kernels and dust from loading and unloading. Issues: mold, dust explosions

Heterogenous demand

Demand is heterogeneous when two or more groups of buyers give different rankings to various qualities.

fruit and vegetables

Demands for most fruits and vegetables are presumed to be homogenous

Challenges of grading

Do grades reflect consumer preferences? What about subjective judgments by graders? Are graders honest? Do the grades measure quality as perceived by buyers? What about quality deterioration after grading? Do grades need to be identical from the farmer to the consumer? Do the grade standards measure only those qualities that are of common interestat every stage? How do traders get the grade boundaries changed? How much diversity within a grade should be allowed? What is the relationship between grading and branding?

Who is the hedger?

FARMERS, LIVESTOCK PRODUCERS-need protection against declining prices for crops or livestock, or against rising prices of purchased inputs MERCHANDISERS, ELEVATORS-need protection against lower prices between the time they purchase or contract to purchase grain from farmers and the time it is sold FOOD PROCESSORS, FEED MANUFACTURERS-need protection against increasing raw material costs or against decreasing inventory values EXPORTERS AND IMPORTERS

Differences between futures and futures vs forward contracts

Forward contract:An agreement between a buyer and seller to exchange something at some future datePerformance is NOT guaranteed.Not Standardized:Each item has to be negotiated Not Transferable Main differences-Most futures contracts do not result in delivery. StandardizationAbility to offset/cancel

MILK AND DAIRY PRODUCT GRADES

Grades of whole milk for consumption are different from most other food grades Quality of milk is alterable

determine basis

Hedging with futures fixed price level but not basis Changing basis can either improve or reduce the price protection of the hedge

Key Characteristics of price organized markets

Important historically & nowOrganized markets are structured to give all potential buyers and sellers public access to one another as they discover pricesOrganized markets are frequently referred to as public markets because the operation is quite public. High level of pricing efficiency is expected!

CONTRIBUTIONS TO PRICING EFFICIENCY:

Increased recognition of value differences Better allocation according to demand Better market news Facilitating futures trading Broadening the market

Margin Account

Initial margin - Initial deposit when the position opened (110% of the maintenance margin) Maintenance margin - Minimum amount to be maintained Margin call - Request for additional funds

Disadvantages of Decentralized, Individual Negotiation

Knowledge of alternate market options is low Lack of information and negotiating skills

disadvantages of organized markets

Less Responsive A major drawback of leading a marketing orientation is that you are usually less rapid in responding to changing customer needs and wants. Emphasis on product improvement can cause companies to spend less time on market research and ongoing interaction with customers. Poor Targeting Another issue that can arise when your company does not make customer needs the starting point is inaccurate or poor target marketing. You may fail to correctly match your brand's capabilities to the right types of customers that have use for them. Missed Market Windows In product categories with fast-moving product life cycles, operating without a marketing orientation can cause you to miss a narrow window of opportunity. High-tech industries, for instance, often have products that enter the market, grow, mature and decline in a matter of months.

liquitdity

Market liquidity is a measure of the market's efficiency.

Hedging with basis

Method 1: Initial future + Actual basis (short term) Method 2: Cash price + Results on futures ( short term) Method 1: Initial future + Actual basis (Long term) Method 2: Initial future - Actual basis (long term)

advantages of price setting systems

Minimizes transactions costs Spatial pricing efficiencyLevel and stability of pricesIntegrity and equity of the price-making process

types of price discovery systems

Organized Markets organized markets -electronic markets decentralized , individual negations

Advantages of Futures versus Forwards

Performance is guaranteed-With a futures contract, the exchange acts as a "middle-man" in every contract.Every buyer and seller deposits "margin" money with the exchange.This procedure is termed "clearing." Standardized terms - all contracts are identical Same quantity Same quality Same time Same location Only thing that is negotiated is price.

Long Hedging

Potential buyer (e.g., miller) Hedge by buying futures contracts now At some future date, sell back the futures contracts (offset), and buy the actual product.

Short Hedging

Potential seller (e.g., wheat producer) Hedge by selling futures contracts now At some future date, buy back the futures contacts (offset) and sell the product.

Price-setting systems types

Price ceiling price support

types of price systems

Price discovery Price-setting systems

Future markets Functions

Risk Transfer - from hedgers to speculators Price Discovery - persons interact to use assimilated information to determine a market clearing price based on different perceptions of where supply and demand factors will be in the future Public access to information - used for decision making Futures markets serve three primary purposes:1.

CONTRIBUTIONS TO OPERATIONAL EFFICIENCY

Saves time for traders Saves time for consumers Saves time for lenders Permitting mixing of separately owned commodities in storage and pooled sales

Key Characteristics of organized electronic markets

Saving time and costs related to travel and commodity transportation are important reasons that have prompted buyer and seller interest in electronic markets. Example of successful electronic markets: eBay In agriculture, electronic trading has been nearly revolutionary Commodity exchanges - U.S.'s CME Group Globex Regional level - Farm Trade, Superior Livestock Auction, etc

Short positions

Seller is short future Buyer short cash

advantages of price organized markets

Some benefits do exist when opportunity with a product or production orientation as opposed to a marketing orientation. Typically, the most innovative and advanced quality products come from companies that make product development central to operations. Consistent improvement and a reputation for quality are sometimes more common to product oriented companies. With a production orientation, your company can improve operating efficiency to moderate costs and enhance potential profitability on sales.

limit down

Soybeans - limit is +/- $1.15/bu Sep Soybean contract settled at $14.00/bu on August 25th "limit down" at $12.85

limit up

Soybeans - limit is +/- $1.15/bu Sep Soybean contract settled at $14.00/bu on August 25th at $15.15, the market would be limit up.

Benefit of speculator

Speculators provide a major benefit to hedgers and the marketplace—market liquidity.

Down fall of pricing systems

The big issue is transaction costs (i.e., all the costs incurred by a buyer/seller as they make and complete deals.Transaction costs are important in determining the system's popularity.

what is a price support

The combination of a minimum price, or price floor, and government purchase of any surplus.

pricing system

a market mechanism or process by which market participants discover, negotiate, or fix prices

market procurement contract definition and characteristics

an agreement between a seller and a buyer covering the product, time and nature of delivery, price, and other aspects of an exchange in which some of the terms do not take place at the time of the immediate transaction

Speculator

an individual or firm that assumes price risk by buying or selling livestock futures in an attempt to profit from a potential change in price or price relationship

Hedger

an individual or firm that uses the futures market to manage or reduce the price risk associated with their cash market position

price quotes

ex: 442'2 you take '2 divide by 2 and place it over four Key words Open - price of the first trade of the session High - highest price during the session Low - lowest price during the session Last - most recent price Close - closing range of prices, final minutes(Prior) Settle - average of the closing rangeNet Change - change from the previous settle E.g.: +6'4 = up 6 ½ from the previous settle

Contractual exchange arrangements

forward contracts are contractual agreements between two parties to exchange a pair of currencies at a specific time in the future

Production contract:

involves the buyer in the physical production process A farmer (contractee) has a production contract when they take responsibility for caring for broilers or feeding pigs owned by another party called a contractor

futures contract

is an agreement between a buyer and a seller that requires the seller to deliver and the buyer to accept delivery of a specified amount of a specified commodity at a specified location on some (specified) future date at a negotiated price. EVERYTHING IS STANDARDIZED, EXCEPT PRICE.

Volume

is the number of contracts traded in a specified period (usually a day). Starts at zero every day Especially important for technical analysis - the charting of trends in current and historical price and trading patterns to predict future price direction

Opening interest

is the total number of contracts open (not offset). Not the same as volume! also important for technical analysis

Price limits

largest permitted change from the previous close

Vertical coordination

ownership of contiguous stages in the marketing channel

Key characteristics of decentralized, individual negation

s a less formalized, less public, less structured but increasingly common pricing system in agriculture. Referred to as haggling or private treaty

Long positions

seller- long cash Buyer-longer futures

what issues does a price ceiling create

such as shortages, extra charges, or lower quality products. Economists worry that price ceilings cause a deadweight loss to an economy, making it more inefficient.

what is a price ceiling

the mandated maximum amount a seller is allowed to charge for a product or service.

price discovering systems

the process of buyers and sellers arriving at prices for a commodity when market conditions do not permit either group to set prices

Grading

the sorting of a commodity into quality classifications

quality

the sum of the attributes of a commodity that influence its acceptability and value to many buyers and the price they are willing to pay