The paper "Hedge Using Futures and Derivatives Disaster" is an outstanding example of a finance and accounting assignment. Futures contract mostly referred to as futures are a set forward contract which is legally binding to a buyer or a seller to buy or sell something at an agreed price after a given period of time in future. According to Hull (2017), some of the common transaction traded involves physical commodities such as maize, oil and precious metals, and financial instruments such as currencies, bonds and mortgage securities. To be precise, this contract gives an avenue to the traders to fulfill a contract to either deliver a commodity or accept delivery or delivery of some sort of financial asset in a future gave date in line to the condition offered in the contracts effective for a price agreed on the contract.
Once a party agrees to accept the delivery of an instrument or a commodity, he or she takes a long position, while the part agreeing to take the delivery of the asset whether financial instrument or commodities assumes the short position. Hedging The purpose of features is for the reason of hedging commodity price against uncertain future price.
Producers who are involved in the selling of commodities such as wheat will not afford to take risk of unknown future prices of their wheat by speculating future prices; instead, famers will enter into a future contract with a willing buyer in a future time. Wisner (2002) explained hedging as taking equal but opposite positions in the cash and futures market. Given the example of wheat farmers, hedging will be a temporal option to them since the wheat will be finally sold in the cash market. Example 1 Assuming a famer who plant wheat takes a short position.
If the famer has 10000 bags of wheat and who has sold the 10000 bags wheat future is in a hedged position. Assuming the price of wheat per bag is speculated to be 30$ after 6 months and the famer agrees to enters into a future contract with a buyer, and after the sixth month the price of a bag of wheat falls to 25$, this will mean there will be a drop of 5$ per bag.
The famer who entered into a futures contract will be hedged against losing the 5% dollar drop per bag which will be the profit earned by the famer. Speculation Hull (2017) explained speculation as; assuming the long position in the underlying asset at an agreed price in the contract with the expectation that after a given period of time, the prices of the commodity will have rose significantly such that they will make a handsome profit in the future. Example 2 Supposing a businessman assumes a long position.
This will mean the businessman agrees to buy a bag of wheat in after a given period of time effective with the price agreed on. Assuming the businessman agrees to buy a bag of wheat at a price of 30$ after the sixth month and reaching the sixth month the price of wheat per bag is sold at 35$ per bag, it will the buyer will buy a bag of wheat at the agreed price of 30$ and sell a bag of wheat at 35$ making a profit of 5$ per bag.
Block,S. and T. Gallagher, “The Use of Interest Rate Futures and Options by Corporate Financial Managers”, Financial Management, Vol 15, 1989, 73 − 78.
Gramatikos, T and A. Saunders, “ Stability and the Hedging Performance of Foreign Currency Futures”, Journal of Futures Markets,Vol. 3, 1983, 295 − 305.
John C. Hull, 2017, Global edition, 8th edition, Fundamentals of Futures and Options Markets, pearson.