Writing assignment #13: A friend of yours farms 600 acres in Ozaukee County. He plans to plant all 600 acres in corn this spring and hopes to harvest approximately 125 bushels per acre in late August. Like all farmers, however, he is worried about a long list of things: what impact will El Nino have on the growing season this year? will we, for example, get too much rain or not enough? will this major weather disturbance have a significant impact on the total amount of corn harvested across the entire country? what will his costs be over the growing season? what price will he his corn bring when he brings it to market in September? After reading the "Futures and Options" section of your Wall Street Journal Guide text, you ask your farmer friend if he has ever considered using the futures market as part of his farming operation. He says, "No, I haven't. How could that help?" Explain how corn futures might be of interest to your friend. Be specific in your explanation of how he might use futures. For example, he will want to know how many contracts he might have to enter and what the total cost is likely to be. He will also want a general description of the risks involved, if any. [You might find the following reference helpful: Principles of Hedging with Futures] Assignment due by Sunday, 4/25/99 %%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%% Date: Thu, 22 Apr 1999 23:28:30 -0500 (CDT) From: Shirley Yu Investing in a futures contract for corn means that you will sell your corn on a particular future date. One can also buy a contract to buy corn on a certain date, but that is not what you are interested in today. Most contracts last an average of less than a year, so you wouldn't have to be in it as long as other investments to make a profit. Many farmers choose futures because they are protected if the prices drop drastically, and there can be a huge drop, but also a huge gain. The contracts you buy are then combined with the rest of the futures contracts from other investors at the Exchange. Then the prices change because it goes into the market and buyers and sellers pair up anonymously. There can be a dramatic change daily on the price of corn, and that is where some of the risk is involved. The price of a contract is determined by two things: the futures market depends on the date of deliver, the destination and the grade of the corn; the cash market is the trading of the actual corn, by processors and terminals. It does not cost that much to buy a contract, relatively speaking. It is usually 2%-10% of the total worth of the corn. So ,if you were to sell 5,000 bushels of corn and each bushel cost $3.00 right now, then the total would be $15,000.00. So you would pay 10% most likely, being a first client for any firm, and that would come to $1,500.00 The risk is that once you are in the contract, there can large dips, but also large rises. For example, you payed $1,500.00 for the contract and you date of delivery is March 10th. During the summer, there is a bumper crop of corn from someplace else. The worth of your contract goes down because the price of the corn goes down. If that happens, you are required to add money to you account to bring it back up to $1,500.00. But, if in August, a huge storm kills off much of the corn fields in the US, the you get a profit if you were to sell then. Hopefully, when it is time to sell yours, there will be a profit. The protection is a benefit for investing in futures and it is called a lock-limit. If the market in futures goes really high or really low, then so does the value of your corn. If it goes to fast, then your contract is protected by the lock-limit. The price locks at its extreme low or high and they don't open or change again until prices go back to acceptable levels. Sometimes, this means huge gain or huge loss. Hopefully, this will help you in minimizing your worries. %%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%% Date: Sun, 25 Apr 1999 12:54:23 -0500 (CDT) From: Djamel Laoufi Corn futures might be of interest to my friend because of the reduced risk of profits (protection) versus selling at the cost of production price or lower. This reduced risk of profits is obtained by selling his future contract of corn in the future, or at time of harvest, at the settled price. This settled price is determined by the CBT(Chicago Board of Trade). My friend could sell his August harvest of corn on the CBT at the price of September, which is set at $2.31 3/4 per bushel. And the minimum per contract is 5,000 bushels. Therefore, if he has 600 acres, and he thinks he will harvest 125 bushels per acre, that would leave him with 75,000 bushels. These 75,000 bushels divided by 5,000 bushels would total 15 contracts. If he is interested in the settled price of the September contract versus the cost of production, and wants to make a profit, he would sell it through a Commodity Broker. This Commodity Broker would charge a fee for this service. If he is interested in the September settled price versus his cost of production, he should sell it. The advantage of selling with futures is he will get protection if there is a fall in the price of corn d/t increased supply and decreased demand. The supply and demand factor would be his biggest risk. If there was too much of corn (high supply) this would lead to a decrease in demand, resulting in a lower price. Even lower than the cost of production. %%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%% Date: Sun, 25 Apr 1999 19:41:10 -0500 (CDT) From: Christopher Paul Peters My friend would purchase corn futures to protect against falling prices of corn. Futures hedgings can help establish corn prices either before or after harvest. By establishing a price he protects against declines in corn prices, if it's because of El Nino or any other disaster. But it also eliminates any potential gain if subsequent prices rise. The futures work by buying hedgers. Now say you buy hedgers at $2.70 per bushel and a flood wipes out the crop. Now the price per bushel is at $2.00, but you can still sell your bushel at $2.70 or you can sell your hedgers for a $.70 profit to offset the low prices. The risks with this is that if the prices rise, he would have to sell at the price that he bought the hedgers at, which would eliminate the potential gain. The farmer friend would have to buy 15 contracts and this would cost him about $3292.50 for the month of May. %%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%% Date: Mon, 26 Apr 1999 00:45:10 EDT From: Un4givin34@aol.com Cc: dbellows@csd.uwm.edu This farmer needs to take a few minutes out of his time to read a Wall Street Journal. On the futures page he will find the prices of corn and what it will be in the future. This summer could be a good or bad harvest. With El Nino being unpredictable this farmer needs to decide for himself what to do with the harvest. If our farmer friend does not plant the crop he may loose money. He could also loose money if his crop dies off because of rain or drought. To make this decision he may need to look at the futures and options page so he knows what to expect in the way of money. To figure prices on the page there is a price for corn per bushel. For September the settlement is 235 1/2 cents per bushel. He could plant the crop later and get more money for waiting until prices go up. This is a risk he is going to think about and make a choice. If his crop comes out good and other corn crops fail in other parts of the country this farmer could come out on top. He can watch the prices in the journal and wait sometime before selling he crop for a higher profit. By entering into a contract with futures our farmer will be set up if corn prices will fall. This will allows him to establish a price before harvest. Generally if prices fall he will lose out, and if they go up he will have more options with his crop for next season. This farmer needs to look in depth into futures. He also needs to look at what prices he will be able to get locally compared to the overall market. Hedging is just a way for this farmer to reduce overall risk. But there may be risks in profitability. By looking in-depth many farmers have trouble making decision in futures prices. %%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%% Date: Mon, 26 Apr 1999 00:27:51 -0500 (CDT) From: Pedro Abundis If my friend was afraid that the future price of corn was going to fall or if he just wanted some secutrity I would advise him/her that the futures market might be something to look into. By selling his corn in the futures market he would be protecting him or her self from possible declines in the price of corn. It could also have the reverse effect and cause him not to profit from any rise in the price of corn. Futures contracts establish a price for the future sell of a harvest and provides the producer with security that he will get payed that amount even if the price of corn declines. With his 600 acres of corn he could potencially grow 75000 bushels of corn or 15 contracts of corn. If he sells the futures contract for september when it is estimated it will cost 230.5 he could sell the 15 contracts for 17,287,500 dollars today (april 9th WSJ) and be secure that he will receive that amount even if the price of corn is below that by september. The only risk is if the price of corn were to rise he might not be able to sell his corn for the higher price because he had already sold it. %%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%% Date: Mon, 26 Apr 1999 16:44:44 -0500 (CDT) From: Mindy M Ward I would tell my friend to take precautions, but don't get paranoid. El nino will not have that big of an impact on Ozaukee County. As for rain, I don't think it will fluctuate more than a normal growing season. Weather disturbances could slightly affect the United States, but I doubt it will be drastic. At any rate, this effect would help my friend because it is more likely that weather disturbances will hit places closer to where El Nino was and diminish as they move towards Ozaukee County. Overall, I can see Ozaukee County having favorable conditions for harvesting corn. Costs of the growing season are dependent on how much machinery he has or uses and hwo the corn progresses. Little rain would require supplemented watering. Also, he must consider prices for running machinery like planters and cobpickers. In addition, he might need extra help from a farm hand which would also cost him money. We must also not forget fertilizing. With all these extra costs, he must be careful not to spend more than he could possibly earn. Instead he must pick and chose what is really necessary and what isn't. Costs can vary from farmer to farmer depending on preferences. I would advise my friend to sign a hedging contract. This is used as added insurance, so that he does not suffer from price changes. There are many benefits in signing such a contract. First, it allows a variable place for delivery. This means he will be able to sell to buyers who are competing. Secondly, he can alter or cancel the commitment if the outlook is rough. In addition, he will hold the contract for longer, allowing the corn to be sold for a year after it is harvested. My friend would probably want to sign another regular insurance contract for his corn producing too, just in case of a physical accident on the fields. With any investment, there are always risks. Something drastic could happen, like a natural disaster or a fire. But he would be covered by insurance. Without proper precautions, my friend could lose his investment in mere days. This year could be a good year for corn all over the United States and my friend could hardly profit at all. I guess overall, anything is possible and unpredictable. A person cannot predict the future, so I would hope for the best for my friend. Corn farming is not an easy job, but experience gives way to more profits. Most farmers are farmers for life; they must enjoy the profits somewhat. But corn producing is not just a thing to all of a sudden invest in without careful thinking and planning. I would also encourage my friend to farmers who have been in the business for years. %%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%% Date: Mon, 26 Apr 1999 12:11:56 -0500 (CDT) From: Jason Paul Gross Using futures to support your corn crop can be a good and profitable way to sell. Basically what you can do is choose to sell a certain amount of corn at a specific time, this assures a price even if the market drop. For example you could offer a contract(future) to sell either 5,000 or 10000 bushels of corn at the market price today. The contract promises the delivery of those bushels at a specific date and they will be sold at the contracted price. Here are some numbers to show you could make money. First in May you harvest your crop of 5000 bushels, you sell a contract for those bushels to be delivered in January. You contracted to sell each bushel for a price of 2.70, January comes around and there is an over abundance of corn. The market for corn is selling for 2.10 per/bushel, so you have make an extra 60 per bushel coming out to be 3000 dollars above the market. There is also a down side to this betting though, if there was a shortage on corn during the winter the market may be offering 3.50 per bushel which causes you to lose 4000 dollars. This way of doing business may seem risky but these contracts can be used to stop a unexpected and dramatic price changes in your crop. %%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%% Date: Wed, 28 Apr 1999 23:46:45 -0500 From: Ryan Johnson The question arises whether or not to let my friend know about corn futures. The answer is an easy one: yes, yes, and yes. This is the kind of market that can constructively use futures they their advantage. The existence of these future contracts allows my friend to price his crop before the actual harvest. The virtually protects the farmer against future price declines, but at the same time it eliminates future financial gains that would have been made by price increases. This can be a catch-22 but the farmer is usually willing to play conservatively because if a fair futures price can be reached it is a better investment to be sure and win small than to not be sure at all. Some people have the luxury to gamble with their money, but unfortunately, farme rs aren^Òt part of that crowd. I would give my friend the following example: Since he can produced 75,000 bushels, (600 acres * 125 bushels/acre) he would be able to enter into 15 futures contracts. If the futures price for delivery of corn in September is $3.00 a bushel. Thus my friend finds it acceptable to sell 75 bushels of Se ptember futures at $3.00. In this case, the 75,000 bushels of futures were sold as a substitute for selling the corn to the local elevator. The expected basis is say, $.30 under the September futures contract, which would yield a price of $2.70 per bushel for September delivery. In the late summer, the corn is delivered to the elevator and the hedge is converted to a cash sale. This is done by selling the bushels of corn to the local elevator at $2.50, and then buying 5,000 bushels of September futures at $2.80. In the example, both the cash price and the futures price move down 20 cents per bushes after the hedge is placed. The loss of cents in the cash market is compensated bye the 20-cent profit in the futures market. Since the objective was not to mak e money on the contract itself (like an investor would try and do) but rather to price corn, the farmer has done what he has set out to do. My friend will be in a constant cycle of hedging, but this method will help him to be more stable in his business, both present and future. %%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%% Date: Thu, 29 Apr 1999 08:20:00 -0500 (CDT) From: Kevin M Hess If my friend was not confident that the future price of corn was going to fall or if he just wanted some secutrity I would advise him/her that the futures market might be something to look into. I would tell him how easy the futures market is, and persuad him to use the futures. By selling his corn in the futures market he would be protecting him or her self from possible declines in the price of corn. It could also have the reverse effect and cause him not to profit from any rise in the price of corn. Its a win win situation. Futures contracts establish a price for the future sell of a harvest and provides the producer with security that he will get payed that amount even if the price of corn declines. What a deal for him, to get paid even if there is a decline in prices. With his 600 acres of corn he could potencially grow 75000 bushels of corn or 15 contracts of corn. If he sells the futures contract for september when it is estimated it will cost 230.5 he could sell the 15 contracts for 17,287,500 dollars today (april 9th WSJ) and be secure that he will receive that amount even if the price of corn is below that by september. The only risk is if the price of corn were to rise he might not be able to sell his corn for the higher price because he had already sold it. The futures market is a great way for a farmer to make it in the farming business. %%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%% Date: Thu, 29 Apr 1999 09:16:18 -0500 (CDT) From: Joseph R Brown when you buy futures you are selling your product for an X amount of money per bushel. This X amount is already set, and after you sell to the futures market, all the worries of the damaging your product are released. And the minimum per contract is 5,000 bushels. Therefore, if he has 600 acres, and he thinks he will harvest 125 bushels per acre, that would leave him with 75,000 bushels. These 75,000 bushels divided by 5,000 bushels would total 15 contracts. The good thing about the futures market is that you are protected from inclimate weather and other harmful products, and you will still get a set amount of money for all your product. The bad thing about futures is that you can profit higher by having a good harvest. Though the season must be a good growing season,if not you will now make much money, but if the season is foolproof with great growing weather you can make much more money than you would in the futures market. %%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%% From stevent@csd.uwm.edu Mon May 3 22:45:08 1999 Date: Thu, 29 Apr 1999 12:36:16 -0500 (CDT) From: Steven A Tokarski To: G Richard Meadows Subject: assignment 13 I think corn futures would be of interest to our friend because who knows what could happen with Wisconsin weather and the effects of El Nino, for all we know his corn harvest could freeze over in September. Our friend would be considered a hedger because he is farmer interested in commodities not a speculator who is there to strictly make money. Hedgers are mainly interested in protecting themselves against price changes that will undercut their profit. Our friend is planning on harvesting 600 acres of corn at 125 bushels an acre which is 75,000 bushels. A contract of corn is 5,000 bushels, so our friend has 15 contracts. Now our friend would be interested in selling his contracts now at the set market price. This way if the impacts of El Nino are drastic our friend loses no money on his corn because its already sold. He could also lose money to if the by the price of the corn going up and he has to sell for a lot cheaper because he already sold. That is what I would do if I were our friend. Steven Tokarski