week 4 course project

ACCT 540

Week 4: Course Project (Case 1)

Typically, hedging strategies are implemented as a means of protection. The dictionary tells us that hedging strategies involve making counterbalancing investments in order to avoid a loss. With regards to the futures market, hedging strategies involve a position in the market that is the opposite of an entity’s current position. Any gain or loss in the cash market is usually followed by a counterbalanced effect in the futures market since the two markets tend to move up and down together. The counterbalanced movement of the two markets is not necessarily identical, but it is usually enough to mitigate the risk of significant loss in the cash market. Hedging is common for farmers or livestock producers that need protection against price drops in livestock or in crops, and also for protection against price increases on purchased inputs such as fertilizer. Like the farmers seeking hedging strategies to mitigate the risks that come with rising prices of purchased goods, Thomas Foods hopes to do the same for the goods they purchase from the farmers.

Several of the sources I came across when researching for this course project included examples that really helped to expand my understanding of hedging strategies and how they work. The example I found to be most helpful was about a hedging strategy employed by a soybean farmer. The article explained that if the soybean farmer plans to sell his crops in October, and he estimates in May that he will sell them for $10 a bushel. If the price per bushel declines between May and October, then the soybean farmer will suffer a loss. The article stated that the farmer could protect himself from potential price declines and hedge by selling an equivalent number of bushels in May in the futures market and then buying them back in October when it will be time for him to sell his crops in the cash market. That way, if the price per bushel declines when it is time to harvest the soybeans, the loss incurred will be offset by a gain from the hedge in the futures market. I learned from a separate source that this particular example would be considered a short hedge because of the initial short futures position. I feel that this example relates to the case I have chosen for the course project because both the soybean farmer and Thomas Foods wish to turn to hedging strategies in order to insulate their income from potential changes in price. Likewise for Thomas Foods, the company can hedge with local farmers prior to harvest, so that if the farmers decide to raise their prices when it is time to harvest the crops, the loss incurred for Thomas Foods will be offset by the initial price paid for the crops in the futures market.

References

Hedging With Commodity Futures Contracts Soybeans Hedge Example. (n.d.).

Retrieved August 2, 2015, from

http://www.usafutures.com/hedgingwithcommodityfutures.html

Hedging with grain futures. (n.d.). Retrieved August 2, 2015.

Self-Study Guide to Hedging with Grain and Oilseed Futures and Options.

(2014). Retrieved August 2, 2015.

Wisner, R., & Hofstrand, D. (2015, July 1). Grain Price Hedging Basics | Ag

Decision Maker. Retrieved August 2, 2015.