1. Market Controversies u Futures markets u Speculation u Captive supplies

2. Futures Market Controversies u Long standing debate u Speculative activity u Occasional proof of manipulation u Possible to trade more than is produced u Close relationship between cash and futures

3. Range of opinions u Organized gambling u Only perfectly competitive market in the country u Highly regulated

4. Important Function of Futures u Price discovery u Risk transfer u Forward pricing

5. Speculators u Speculators, Pro –Add liquidity to market –Assume price risk in hope of making a profit

6. Speculators u Speculators, Con –May mis-price commodity because they are not farmers –Herd mentality –Large volume “Funds”

7. Speculators on Average Lose u Zero-sum game –Gains = losses –Brokers are always paid u Beware of “sure-fire” systems –Difficult to beat the market –Why share valuable information

8. Futures to Cash Relationship u Both are jointly determined by the same market forces u Futures are an anticipatory market and may change prior to the cash market giving the appearance that futures lead cash

9. Futures to Cash Relationship u Futures incorporate information u Price discovery role u Large volume, instantaneous information interpretation may cause over reaction and exaggerate price fluctuations

10. Does Hedging Work? u What are the objectives??? –Risk management: Don’t sink the ship –Price enhancement: Don’t miss the boat u It is a marketing tool to be used selectively to achieve specific objectives

11. Potential Manipulation u Illegal and highly regulated –Commodity Futures Trading Commission (CFTC) –Limits on number of contracts held –Price limit movements u Difficult to accomplish –Hunt brothers

12. Forward Contract Controversies u Hedge to Arrive u Captive supplies –Market power –See Captive Supply presentation u Long term contracts –Market power –Price discovery –Encourages expansion

13. Hedge to Arrive (HTA) u 1995-96 corn market u Promoted as a way to capture “highest prices in years” u July - Dec spread was “too wide” and should narrow. u Sell multiple crops in one year

14. Spread “too wide” u Sell the July now then if: u July goes down –Dec should go down less (narrow) –Buy back July and sell Dec u July goes up –Dec should go up more (narrow) –Buy back July and sell Dec u Gain from narrowing spread

15. “Hedge” in July contract u Elevators offered HTA contracts –Elevator took futures position –Farmer was to deliver bushels u Spread did not narrow u July futures increased Dec didn’t u No crop in July - can’t deliver

16. HTA u Elevator (often coop) had margin calls –No grain to make a hedge u Farmers couldn’t or wouldn’t deliver grain –Some had 3 crops sold well below the market

17. Lessons from HTA u History is not a perfect predictor of the future u Understand contracts –Put everything in writing –Read all the writing u Properly used HTA can be a good marketing tool