Commodity Futures Market: Its Mechanics and Uses

Date of Submission

1975

Document Type

Thesis

Degree Name

Master of Business Administration (MBA)

Department

Management

Advisor

George S. Schaefer

LCSH

Commodity exchanges

Call No. at the Univ. of New Haven Library

AS 36 .N29 Bus. Adm. 1975 no.5

Abstract

(Introduction, pp. 1-2) Many people today are familiar with the world stock exchanges and how common stocks and bonds are traded. Fewer persons have a working knowledge of commodity futures. The commodity exchanges trade such things as metals, grain, livestock,and other foods for future delivery. Commodity futures trading offers a unique price risk protection to commercial businessmen who use futures as part of their regular business operation. The purpose of this thesis is to show the business use of commodity futures, using copper as an example.

When a businessman buys a fire insurance policy he is hedging against the risk of a fire. If his building burns down, the insurance company will pay a large part, if not all, of the rebuilding costs. For this protection against the risk of fire, the businessman pays the insurance company an annual premium that is very low relative to the cost of the building. Hedging in a commodity future is a way for the businessman to protect himself from the risk of large price fluctuations. The hedger uses the futures market as a price-protection mechanism for establishing the price at which he will buy or sell his inventory of a commodity at a future time. The hedger is someone who is involved in the physical production, processing, handling or marketing of the actual commodity. He uses the futures market as an integral part of his commercial business.

Commodity futures also provide one of the last areas where vast profits can be made by persons inclined to speculate. The "speculator" provides the market with risk capital in hope of making a large profit. He assumes the risk of price fluctuation that the hedger does not want. The speculator is only interested in price changes. He buys in anticipation of a price rise and sells when he thinks that prices will decline. He is risking his own money on his ability to predict these price movements. The speculator does not own or produce or process the actual commodity product. He may not even know what the commodity looks like.

It is essential that both hedgers and speculators participate in the commodity market. If the market did not provide an economic function for the hedger, there would be little need for the market to exist. If the speculator was not willing to assume the hedger's risk, there would be no market. Together they make orderly markets in grain, livestock, metals, and other commodities including cocoa, cotton, orange juice, potatoes, sugar, and lumber.

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