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Hedging & Futures. Presented by Jonathan Truong. Agenda. Futures Review What is Hedging What to Consider Wheat Example Gas Example. Review on Futures . Forward contract Many players Make/take deliveries Speculating prices Open/close positions Clearing house. Hedging.
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Hedging & Futures Presented by Jonathan Truong
Agenda • Futures Review • What is Hedging • What to Consider • Wheat Example • Gas Example
Review on Futures • Forward contract • Many players • Make/take deliveries • Speculating prices • Open/close positions • Clearing house
Hedging • What is hedging? • Future contracts to limit exposure to commodity prices • Used to offset natural risk exposure on profits and expenses • Not meant for income production mechanism
Things to Consider • Hedging with future contracts • Maturity • Units of commodity per contract • How many contracts you need • Initial margins to initiate positions • Maintenance margin
Wheat Contract Farmer • Contract – sell (short) 4 • Contract = 50,000 bushels @$4.50/bushel • Maturity is 1 month/contract • MM is 10% Notional • 4(50,000*4.5) = $900,000 • MM = .10*90,000 = $9,000 Baker • 4 contracts/mo
Scenarios • month 1 • Bumper crop • 4(50,000*4.5) = $900,000 • 10 contracts extra of bushels (no futures) • Spot sell • Assume demand was low, @$4.4/bushelAssume demand was high, @$4.7/bushel • Farmer savings in contracts • 4(50,000(4.5-4.4)) = +$20,000 | 4(50k(4.5-4.7)) = -$40,000 • Farmer loss/savings in extras (not in futures) • 10(50,000(4.4-4.5)) = -$50,000 | 10(50k(4.7-4.5)) = +$100,000 • Net delta -$30,000 +60,000
Scenarios • Drought • Able to deliver partial contract for that month/all/no futures • Spot deliver the rest @$5.70/bushel
Delivery Company Example • 90,000 gallons of fuel • Hedge for next 3 months • 2 contracts/month x 3mo • Margin is $68,850
Exp. Information • Average price for a gallon: $3.50 What are the fuel savings? month 1 = 90,000($3.50 - $3.25) =$22,500 month 2 = $45,000 month 3 = $63,000 Gain from fuel savings = $130,000
How much did you lose on your futures contracts? month 1 = 84,000($2.6813 - $2.8974) = - $18,152.40 month 2 = - $39,127.20 month 3 = - $55,935.60 loss on future = -$113,215.20
Review Q. • Was this a good hedge?
References • "Hedge (finance)." Wikipedia. Wikimedia Foundation, 18 May 2013. Web. 22 May 2013. • "Introduction to Hedging with Futures." YouTube. YouTube, 18 Dec. 2011. Web. 23 May 2013. • Kuepper, Justin. "Speculating vs. Hedging With Futures Explained." Commodity HQ. N.p., 23 Dec. 2012. Web. 25 May 2013. • "What Is the Difference between Hedging and Speculation?" What Is the Difference between Hedging and Speculation?N.p., 26 Feb. 2009. Web. 25 May 2013. <http://www.investopedia.com/ask/answers/06/hedgingversusspeculation.asp>. • Wisner, Robert. "Principles of Hedging with Futures." MARKETING & UTILIZATION Cooperative Extension Service. Purdue University, May 2002. Web.