Futures Market Explained

Harvest Public Media

25 May 201604:27

Summary

TLDRThe video script explains how the futures market stabilizes the price of processed foods like corn cereal despite fluctuating corn prices. Farmers and cereal companies use futures contracts to hedge against price volatility, ensuring neither faces financial ruin due to market changes. This risk management strategy helps maintain a balance, keeping consumer prices stable and predictable.

Takeaways

🌽 The price of a box of corn cereal remains stable despite the fluctuating prices of corn due to the use of the futures market.
📉 Corn prices can change daily, affecting the cost of crops but not necessarily the price of processed food like corn cereal.
🛡️ The futures market acts as a risk management tool, allowing sellers and buyers to insulate themselves from price volatility.
👩‍🌾 Corn producers face the challenge of selling their entire crop at once, which can lead to a temporary oversupply and price drop.
🏭 Corn users, like cereal companies, prefer not to buy all their corn at once due to storage costs and the desire to manage inventory effectively.
📅 Futures contracts can be made at any time, even before the corn is harvested, providing a form of security for both farmers and cereal companies.
💹 Futures contracts provide a hedge against price changes, ensuring that neither party is solely at the mercy of the market price at the time of transaction.
📈 If corn prices rise, farmers may lose money on their futures contracts but can sell the remaining corn at a higher market price to offset the loss.
📉 Conversely, if corn prices fall, the futures contracts can make money, which can help farmers offset the lower market prices for their corn.
🛒 The stability provided by the futures market helps maintain a balance that keeps the cost of corn cereal affordable for consumers.

Q & A

Why does the price of processed food like corn cereal remain stable despite fluctuations in corn prices?
-The stability of processed food prices is partly due to the use of the futures market, which allows sellers and buyers of corn to hedge against price fluctuations, thus insulating consumers from these changes.
How does the futures market help corn producers and cereal companies manage price risks?
-The futures market enables corn producers and cereal companies to enter into contracts that set a price for future transactions, providing a hedge against unfavorable market price changes.
What is the problem faced by the corn farmer when it comes to selling her crop?
-The corn farmer faces the problem of having her entire crop harvested at once, which can lead to a temporary oversupply and a drop in market prices.
Why wouldn't a cereal company want to purchase all its corn at once when prices are low?
-A cereal company wouldn't want to purchase all its corn at once due to the costs associated with storage and the potential for prices to change in the future.
How can the storage of corn be beneficial for the futures market?
-The ability to store corn allows for its sale and purchase throughout the year, which is essential for the functioning of the futures market where contracts are made for future delivery.
What is the role of contracts in the futures market for corn transactions?
-In the futures market, contracts are used to buy and sell bushels of corn, providing a means for both parties to secure a price and manage the risk associated with price volatility.
How does a futures contract provide security for a corn farmer?
-A futures contract allows a corn farmer to sell a portion of her anticipated crop at a set price in the future, ensuring a minimum income even if market prices drop at harvest time.
What is the strategy of a cereal company in using futures contracts to protect against high corn prices?
-A cereal company uses futures contracts to buy corn at a predetermined price, which protects them from having to pay high market prices if corn becomes more expensive.
How do gains or losses in the futures market contracts affect the actual sale of corn?
-Gains or losses in futures contracts can offset the actual sale prices of corn. For instance, if the market price is high, a farmer might lose on the contract but can sell the unsold corn at a higher price, and vice versa.
What is the primary purpose of the futures market in the context of corn and cereal production?
-The primary purpose of the futures market in this context is risk management, ensuring a balance that helps maintain stable prices for consumers and businesses.
How does the futures market contribute to the stability of the corn cereal price for consumers?
-The futures market contributes to the stability of corn cereal prices by allowing producers and manufacturers to manage price risks, which in turn helps prevent drastic price increases that would affect consumers.

Outlines

00:00

🌽 Understanding the Stability of Processed Food Prices

This paragraph explains the stability of processed food prices despite the fluctuating prices of raw materials like corn. It introduces the concept of the futures market, which allows sellers and buyers of corn to mitigate price volatility. The farmer aims to sell corn at a high price, while the cereal company wants to buy at a low price. The harvest season creates a challenge due to the simultaneous influx of corn into the market, which can lower prices. The paragraph also touches on the storage of corn and how it enables year-round trading, setting the stage for the role of futures contracts in stabilizing prices.

Mindmap

Keywords

💡Futures Market

The futures market is a financial marketplace where participants can trade standardized contracts for future delivery of an asset, such as commodities or financial instruments. In the context of the video, the futures market allows corn producers and cereal companies to mitigate price risk by locking in prices for future transactions. This is crucial for both the farmer, who wants to sell her corn at a profitable price, and the cereal company, which wants to secure a steady supply at a predictable cost.

💡Hedge

A hedge, in financial terms, is a strategy used to reduce or offset potential losses or risks. In the video, farmers and cereal companies use futures contracts as a hedge against the fluctuating prices of corn. By entering into these contracts, they can protect themselves from unfavorable market conditions, ensuring a more stable income and cost structure, respectively.

💡Price Fluctuation

Price fluctuation refers to the changes in the market price of a commodity or asset over time. The video script mentions that corn prices can change daily, sometimes by a few cents and sometimes by a lot more. This volatility can pose a significant risk for both producers and consumers of corn. The futures market helps to stabilize these fluctuations by allowing participants to lock in prices for future transactions.

💡Commodities

Commodities are basic goods used in commerce that are interchangeable with other goods of the same type. Corn, as discussed in the video, is a commodity that is traded in the futures market. The price of commodities like corn can be influenced by various factors such as supply and demand, weather conditions, and market speculation.

💡Contracts

In the video, contracts refer to the agreements made in the futures market where buyers and sellers commit to a future transaction at a predetermined price. These contracts are central to the futures market's function, as they allow participants to manage risk and ensure a certain level of price stability for their business operations.

💡Supply and Demand

Supply and demand is an economic principle that describes the relationship between the quantity of a product available in the market and the desire for that product among consumers. The video highlights how the simultaneous harvest of corn by many farmers can lead to an oversupply, which in turn can cause prices to fall. The futures market helps to balance these market forces by allowing for the buying and selling of corn throughout the year, not just at harvest time.

💡Storage

Storage in the context of the video refers to the ability to hold onto a commodity, such as corn, until it can be sold at a more favorable price. The script mentions that the cereal company does not want to purchase all of its corn at once due to storage costs. However, the ability to store corn is also what allows the futures market to function effectively, as it enables the buying and selling of corn throughout the year.

💡Risk Management

Risk management is the process of identifying, assessing, and prioritizing risks to an organization's capital and earnings. In the video, the futures market serves as a risk management tool for both corn producers and cereal companies. By using futures contracts, they can mitigate the risk of unfavorable price movements, thus protecting their businesses from potential financial losses.

💡Profit

Profit in the video is discussed in the context of gains or losses made through the futures market. If the market price of corn goes high, the farmer may lose money on her futures contract but can offset this by selling the rest of her corn at the higher market price. Conversely, if the price is low, the profit made on the futures contract can shield her from the lower prices she receives for her corn. Similarly, the cereal company can use profits from its futures contracts to cover higher corn prices.

💡Stability

Stability in the video refers to the goal of maintaining a consistent and predictable price for commodities like corn, which in turn helps to keep the cost of processed foods, such as corn cereal, stable for consumers. The futures market contributes to this stability by allowing market participants to manage price risks and avoid extreme price fluctuations that could disrupt their businesses or consumer budgets.

Highlights

The price of processed food like corn cereal remains stable despite fluctuating corn prices.

The futures market plays a crucial role in stabilizing the cost of processed food.

Farmers and cereal companies use futures contracts to protect against price volatility.

The harvest of corn is a simultaneous event for many farmers, which can lead to price drops.

Cereal companies prefer not to purchase all their corn at once due to storage costs.

Corn can be stored, allowing for year-round trading in the futures market.

Futures contracts provide a hedge against price changes for both farmers and cereal makers.

Contracts can be made before the corn is even planted, offering security to farmers.

The cereal company uses futures contracts to protect against high corn prices later on.

If the market price goes high, farmers can sell the rest of their corn at a higher price, offsetting losses from the futures contract.

Conversely, if corn prices are low at harvest, farmers can profit from their futures contracts.

Cereal companies can use profits from futures contracts to offset higher corn prices.

The futures market is a risk management tool that focuses on balance rather than maximizing profit.

Stability in the cost of cereal helps maintain a consistent weekly shopping budget for consumers.

The futures market allows for bushels to be traded without actual corn changing hands.

Farmers and cereal companies can enter into futures contracts at any time to manage price risks.