Question

Elevators and processors use a number of different types of contracts when they purchase commodity. The contracts are a tool they can use to make secure commodity delivery to them when they need it. These contracts are different from futures or options in that it is not possible to offset a contract with an elevator or processor. They are all tools that producers can use to manage their price risk For each of the following contracts explain how the contract works. Describe the advantages and disadvantages to the commodity seller (producer) of each of these types of contracts. Please use appropriate terminology in your explanations. 1. Cash Forward Contract 2. Delayed Price Contract (AKA No Price Established or Deferred Price) 3. Storage Contract 4. Minimum Price Contract 5. Futures Fixed or Hedge to Arrive Contract 6. Basis or Basis Fixed Contract 7. Min-Max Contract

Needs help with 5,6,7. I have the top 4.

Answer 1

1. Cash Forward Contract:

FUTURES + BASIS - (FREIGHT & MARGIN) = CASH

Forward contract is a non-standardized contract between two parties to buy or sell an asset at a specified time at an agreed price.

Advantages of forward contracts are as follows:

* They can be matched against the time period of exposure as well as for the cash size of the exposure.

* Forwards are tailor made and can be written for any amount and term.

* It offers a complete hedge

* Provide Price protection

* Easy to Understand

Disadvantages of forward contracts are:

* It requires trying up capital. There are no intermediate cash flows before settlement.

*Subject to default risk.

*Contracts are difficult to cancel.

*Difficult to find counter party

2.Delayed Price Contract

No Futures+No Basis = No Cash

Producer delivers the grain and gives up all rights to the grain

• Elevator has right to ship grain
• Producer locks in nothing, futures, basis and sometime scales are left unpriced
• Producer must take LDP before delivery

Best Time to Use

• Harvest, but most elevators don't offer then
• Early spring

Advantages of Delayed Price Contract

• Ship Grain immediately
• Receive money as soon as sold
• Eliminates the chance of storage problems
• Can take advantage of futures and basis improvements

Disadvantages of Delayed Price Contract

• Unlimited price risk
• Not secured by anything, if elevator folds you lose grain and potential income

Minimum Price Contracts

FUTURES + BASIS - (FREIGHT & MARGIN) = CASH

The Minimum price contract allows the producer to lock in a minimum price and still have the opportunity to take advantage of higher prices that may occur later.

Advantages of Minimum Price Contracts

• It reduces downside risk by setting the minimum the seller must accept.
• The seller has the flexibility to set a higher price later, if the opportunity rises.
• Upon delivery, grain condition and storage risk pass to the grain dealer and the producer receives at least the MSP.
• Generally you can contract for any quantity of grain. In some cases, minimum bushel amounts may be required.

Disadvantages of Minimum Price Contracts

• It is generally the seller responsibility whether the basis and premium adjustments made to the futures price are acceptable.
• In the event the futures market moves above the initial agreed upon strike price it is generally the sellers responsibility to notify the grain dealer to lock in a price above the MSP.
• Seller forfeits any futures basis again
• Seller incurs cost of the price insurance

Future Fixed or Hedge to arrive contract:

FUTURES + BASIS - (FREIGHT & MARGIN) = CASH

A hedge-to-arrive contract allows the producer to lock in a futures price with the elevator, leaving the basis to be set at a later time. The elevator will establish a hedge in the futures on your behalf in exchange for delivery of the cash commodity at a set time. This contract is useful if futures prices are relatively high and market conditions lead you to believe that they will weaken and/or you think that there is room for improvement in basis levels. A hedge-to-arrive contract will be written for delivery of a specific amount of grain , a specific shipment period, and the set futures price.

Advantages:

• Limits downside futures price risk.
• Can take advantage of basis improvement.
• No margin requirements to the farmer, since the elevator is carrying the position.
• May be allowed to buy back the contract if you are unable to deliver.
• May be allowed to roll the contract to a later month in the same crop year.

Disadvantage :

• Can't participate in futures rally.
• Downside basis risk.
• Must monitor basis levels closely to lock them in when high.
• Locked in to the elevator and required to deliver (unless allowed to buy back the contract).
• If grain is delivered prior to pricing basis, there may be service charges.
• This type of contract can only be executed during trading hours

Basis Fixed Contract:

FUTURES + BASIS - (FREIGHT & MARGIN) = CASH

In this type of contract, the producer locks in a favorable basis with the elevator, leaving the futures price to be set later. Basis contracts are used successfully when the basis is at historically high levels and market conditions lead you to believe that there is room for improvement in futures prices.

A basis contract allows the producer to collect a 70-75% advance on their final estimated payment upon delivery of the grain.

If the deadline comes when you must lock in the futures price, but you want to leave the option open and allow for further possible futures price increase, you may roll the basis contract into a deferred futures month.

Advantages:

• Eliminates downside basis risk.
• Can take advantage of potential futures price increase.
• Can collect an advance on delivered grain without locking in the final cash price.
• No storage costs.
• By "rolling the basis" contract can remain unpriced for extended period of time.

Disadvantages:

• Risk of futures price decrease.
• Required to deliver grain as stated in contract.
• Must track the futures and market trends to lock in a favorable futures price.
• Full payment is not made until the futures price is locked in.