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AGEC 420

AGEC 420. Form groups of 3 – by Monday Notify by e-mail Need $$ Cox, Giles, Johnson, Pankratz, Wickstrum Need names dlk7958, djs4343, kan9933,. Margins. Set by the exchange typically around 5% of contract value MidAm Wheat - $149 (approx 5% of 1000bu * $3)

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AGEC 420

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  1. AGEC 420 • Form groups of 3 – by Monday • Notify by e-mail Need $$ Cox, Giles, Johnson, Pankratz, Wickstrum Need names dlk7958, djs4343, kan9933,

  2. Margins • Set by the exchange • typically around 5% of contract value • MidAm Wheat - $149 (approx 5% of 1000bu * $3) • will be increased in response to increased price or price volatility

  3. Margin – example 1 • MidAm Wheat • Contract = 1000bu • Initial margin = $149; Maintenance = $110 • Sell March @ 285.5 • Close next day @ 288 • Receive margin call ?? • NO – (loss was $25)

  4. Margin – example 2 • MidAm Wheat • Contract = 1000bu • Initial margin = $149; Maintenance = $110 • Buy March @ 285.5 • Close next day @ 279 • Receive margin call ?? • YES – Margin call for $65

  5. Commissions • Set by your broker • Varies by exchange, by commodity, and by type of trade. • Range: $20 to $200 !! • Buchanan & Co. • Cattle @ MidAm (MACE): $30 per round turn • i.e., $15 in, and $15 out

  6. Who uses futures --- and why? • Hedgers • agents dealing in the physical commodity • producers: growers, feeders • processors: millers • handlers: elevators, terminals • Speculators • no position in the physical commodity • accept risk, hope to profit • provide liquidity (trade volume without delay)

  7. Functions of Futures Markets 1. Risk transfer: • from Hedgers • who want to manage (reduce) risk • to Speculators • willing to accept risk 2. Price discovery: • provide market’s best guess of the future price • reflects available info. on future supply and demand

  8. Hedging Definition an attempt to reduce (manage) price risk by taking a position in the futures market opposite to that held in the cash market i.e., its an effort to lock in a price – either for selling or buying

  9. Why hedge? • To obtain protection from an adverse price movement How ? • by an opposite position in futures to the position in cash

  10. For hedging to work • You need the cash price and the futures price to move in the same direction • if they don’t – then the hedge won’t work

  11. Basis difference between cash price and futures price Basis = Cash minus Futures Examples • Salina cash price $2.90/bu, March futures $3.00 • Salina basis is - $0.10 (10 under) • G.City cash price $2.80/bu, July futures $3.00 • G.City basis is - $0.20 July (20 under July)

  12. Basis • Always quoted relative to some futures month • If the futures month is not specified  assumed to be the nearby futures

  13. Basis • Basis = Cash - Futures • ===> • Cash = Futures + Basis

  14. Basis and Time • Basis can change over time • strengthen • from -10 to -5; from -5 to +2; from +2 to +6 • weaken • from +10 to +7; from +7 to -3; from -3 to -6

  15. Basis and Location • Basis varies with location • because supply-demand conditions are different in different areas • Kansas -- basis typically negative • Near Gulf ports -- basis typically positive

  16. Maturity Basis the difference between the cash price and the futures price at the maturity date of the futures contract Example • the difference between the cash price in Salina and the July futures price in July

  17. Maturity Basis • Predictable – using historical data • But not perfectly predictable  there is “basis risk”

  18. Quiz #1 – next week For 1/2 point extra credit on Quiz #1 Approximate size of Ireland relative to Kansas

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