Commodities - Hedgers

CFA Level II Alternative Investments
#1

I do not understand the sentence : “A firm that produces breakfast products that use use corn as in input is short in the corn spot market, as it benefits when corn prices drop and its input costs fall. Consequently, the firm will take (opposite) long position in a futures market to hedge the commodity price risk.” For instance, if the locked price in the futures contract is 13€/kg corn so the firm will go long/buy 39€ for 3kg corn in the futures. But let’s say at the term of the futures contract, the spot price of corn is 10€/kg. So the firm will make a loss of 9€? What is the point of buying and then selling? By the way, why does the breakfast products industry sell its input corn? It needs it to realize its products. Or I supposed I missed something.

Thank you for your help

#2

If they lock in a price of EUR 13/kg, they protect themselves from a price increase.

What’s the cost? They lose out if the price decreases.

They don’t sell the corn; they settle the futures contracts in cash.

#3

Don’t get your last sentence. The selling in the spot market is related to related to the long in the futures contract? Thank you

#4

Suppose that they lock in the price of EUR 13/kg.

When the contract expires:

  • If the price of corn is EUR 10/kg, then they pay EUR 10/kg for the corn to make their cereal, and on the futures contract they have to pay (agreed − spot) = (EUR 13/kg − EUR 10/kg) = EUR 3/kg. So their total payment is EUR 10/kg to the corn seller plus EUR 3/kg to settle the futures contract = EUR 13/kg.

  • If the price of corn is EUR 15/kg, then they pay EUR 15/kg for the corn to make their cereal, and on the futures contract they have to pay (agreed − spot) = (EUR 13/kg − EUR 15/kg) = EUR −2/kg (i.e., they receive EUR 2/kg). So their total payment is EUR 15/kg to the corn seller less EUR 2/kg to settle the futures contract = EUR 13/kg.

#5

Ok so the “the firm is short in the spot market” part is related to difference between the price agreed in the future market and the actual spot price?

#6

Yup.

#7

Ok I get it. Thank you very much for your clear explanations

#8

My pleasure.