Definition u A market is an arena for organizing and facilitation business activities. u Define a market –FormWhat –PlaceWhere –TimeWhen –Institutional level Who

Examples u Iowa-Southern Minnesota u Hog carcasses u 185 pound, 51-52% lean u Plant delivered u January 10, 2003 u Boneless pork loins –Farmland –Hormel u Hy-Vee meat department u Ames, Iowa u January 10, 2003

Cash or Spot Market u When: Immediate ore near-term delivery u What: Commodities –Defined by minimum standards –Often set by USDA u Where: Typically at buyer’s location –Elevator, processor, auction u Who: Depends on level –Farmer-first handler-processor-wholesaler- retailer

Cash or Spot Market u #2 yellow corn, Heartland Coop at Nevada, January 5, 2004, farmer to first handler. u #1 yellow soybeans, north central Iowa elevators, January 5, 2004, farmer to first handler. u Fed cattle 65-80% Choice, Nebraska feedlots, January 7, 2004, feedlot to packer u Iowa-S. Minnesota 51-52% Lean hogs, plant delivered, January 7, 2004, farmer to packer. u Medium-Large Frame steers pounds, Dunlap Iowa Auction, January 3, 2004, cowherds to feedlots.

Futures markets u Today’s price for products to be delivered in the future. u A mechanism of trading promises of future commodity deliveries among traders. u Biological nature of ag production –Prices not known when production decision is made –Processors need year around supply

Futures Market Exchanges u 12 organized exchanges u Two largest –Chicago Board of Trade (CBOT) »Grains, interest rates » –Chicago Mercantile Exchange (CME) »Livestock, financial, currencies » –Combined for 75% of futures volume

Semester long assignment u Choose and follow a commodity each week throughout the semester. u Due each Tuesday –Brief (less than one page) analysis of factors that impacted the market the previous Monday – Friday –Calculate your margin account based on Friday’s close.

Sources for information u Links also on class web site u Cash – – bin/Notes/rnoteindex.pl?COMMODITY u Futures – – u Analysis – cals/ifo/ –

Due Tuesday Jan 20 u Pick a commodity u Define the cash market and report the price. u Find and report the futures price for the same commodity for Friday. –Choose a contract month that expires after the end of the class. –July or later for corn, wheat, or soybeans –June or later for cattle, feeder cattle and hogs

Futures Market Exchanges u Trading pits u Centralized pricing –Buyers and sellers represented –All information represented u Perfectly competitive market –Open out-cry trading

The futures contract u A legally binding contract to make or take delivery of the commodity –Form (wt, grade, specifications) –Time (delivery date) –Place (delivery location) –Possession (seller delivers, buyer receives)

The futures contract u Standardized contract u No physical exchange takes place when the contract is traded. u Deliveries are made when the contract expires (delivery time) u Payment is based on the price established when the contract was initially traded.

Standardized contract u Certain delivery (contract) months u Fixed size of contract –Grains 5,000 bushels –Livestock in pounds »Lean Hogs 40,000 lbs carcass »Live Cattle 40,000 lbs live »Feeder Cattle 50,000 lbs live u Specified delivery points –Relatively few delivery points

Market position u Objective: Buy low, sell high u You can either buy or sell initially –Sell a December Corn contract initially »Short the market »Buy back at a later date –Buy a February Live Cattle contract initially »Long the market »Sell back at a later date

Margin account u Highly leveraged trades –Margin is the earnest money that must be maintained in the trader’s account –Often 5-10% of full value u Margin account settled everyday –Must maintain account balance –Margin call u Calculate as if you had to get out of the market every day.

Margin Account Example u Corn Contract –5,000 $2.80 = $14,000 –Margin = $500 u Cattle contract –40,000 $.70 = $28,000 –Margin $1,000

Margin Account u Initial margin: The amount needed to open and account. u Maintenance margin: The minimum amount needed to keep and account open. u “Mark to the Market” at the close of each trading day.

Margin Account Example u Initial margin$1,000 u Maintenance margin$800 u Corn contract (5000 bushels) –Day 1:Sell at 2.55

Margin Account Example DayPriceChgG/LMargin Below Maintenance Margin must make $100 margin call Changes reflect the initial “sell” of the contract

Margin Account Example Note that you can calculate your margin account if you know the initial margin, any additions or removals and the current closing price.