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Solomon Neuhardt discusses forwards and futures markets – part 2

An example of a forward contract is where you want a loan in the future of a certain maturity but want to nail down the interest rate on the loan now. This is also called a forward rate agreement.

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In contrast to a farmer, an arbitrageur might actually want to take delivery and make money on it. Arbitrageurs carefully monitor the prices on the day contracts expire to see how they can profit. The futures price and the spot typically converge when contracts are about to expire.
Cross hedging is the process of one party using one type of corn against another type of corn to hedge their risk. They are crossing from one product to another.

Most futures have migrated to financial instruments now rather than focusing on agricultural products as they have done historically for hundreds of years. Commodities such as crude oil, natural gas and gold are popular. Furthermore, most futures prices that used to be in print in the Wall Street Journal have migrated to the internet in the last ten years or so.

Corn and grain prices usually spike when oil prices are high. The theory is that corn or grain can be used as an alternative to oil for fuel or for making fuel. The problem with corn being higher is cost is that food prices can be significantly affected. The poorest parts of the world cannot tolerate a doubling of the price of grain, such as that occurred in the late 2000s during the financial crisis and beyond. By comparison, the price of corn has come down dramatically since 1929 and incomes have risen. These numbers are CPI adjusted.

The price of grain is lower after a harvest comes in and the warehouses are full and increases in price as the supply diminishes. Backwardation is a concept where the futures prices is less than the spot price. It is possible for someone to make money by finding grain that is to be delivered in the future and selling it on the spot market. When the market is in backwardation the only wheat that is not being sold on the spot market is there for convenience purposes, such as the manufacturer of Wheaties who needs it for the cereal.

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