Chapter Six

Managing Agricultural Marketing Risks Using Futures Markets

RISKS IN MARKETING 
• Risk is inherent in all marketing transactions. Fire, rodents, quality
deterioration, price fall, change in tastes, habits or fashion, placing the
commodity in the wrong hands or area are all also associated with
marketing risk.
• Hardy has defined risk as uncertainty about cost, loss or damage.
• The longer the time lags between production and consumption, the greater
the risk.
• Most of the risk is taken by market middlemen.
• The bearer of the risk may be better off or worse-off.
• A risk cannot be eliminated because it also carries profit.
6.1. Types of Risk in Agricultural Marketing
1) Production/Physical risk: uncertain of natural growth: weather, disease,
pests, fire and other factors during storage and transportation may loss in
both quantity and quality of products.
2) Price or market risk: uncertainty prices producers will receive for
commodities; fluctuation of price; or the prices farmers must pay for
inputs.
3) Financial risk: borrows money and repay debt, interest rates, restricted
credit availability and others.
4) Institutional risk: gov’t actions, tax laws, regulations for chemical use,
rules for animal waste disposal, and the level of price or income support
payments.
5) Human or personal risk: human health or personal relationships:
accidents, illness, death, and divorce.
6.2. Future Markets
It is an obligated contract between two parties to sell or buy an asset at a
predetermined future date and price.
Market-based instruments for managing risks and establishing efficient
markets.
Important method for agricultural producers as
a) to hedge revenue risk, which can be very high.
b) To face significant risks of events.
c) To hedge commodity prices.
d) to remove the risk of fluctuating and unknown sale prices.
e) To serve low cost.
f) to create and trade futures contracts between a buyer and seller.
 Con’t
• Measures to Minimize Risks:
Reduction in Physical loss through fire proof storage, proper packing and better
transportation.
Transfer of physical losses to Insurance companies. 
Minimization of price risks through. 
• Fixation of mini
• mum and maximum price by government. 
• Dissemination of price information to all sections of society over space and time. 
• Effective system of advertising and create a favorable atmosphere for the
commodity.
• Operation of speculation and hedging : Futures trading, forward market, contract
farming, contract marketing.
 Con’t
Speculation : Purchase or sale of a commodity at the present price with the
object of sale or purchase at some future date at a favorable price. 

Hedging : It is a trading technique of transferring the price risk. “

• Hedging is the practice of buying or selling futures to offset an equal and
opposite position in the cash market and thus avoid the risk of uncertain
changes in prices”
• Futures Trading: It is a device for protecting against the price fluctuations
which normally arise in the course of the marketing of commodities.
Stockiest, processors or manufactures utilize the futures contracts to transfer
the price risks faced by them.
1. Future Contracts
A standardized agreement to buy or sell a commodity at a date in the future.
It specifies:
a) Commodity: live cattle, feeder cattle, lean hogs, corn, soybeans, wheat,
milk, and so on.
b) Quantity: number of bushels of grain or pounds of livestock as well as the
range of weight for individual animals.
c) Quality: specific grades.
d) Delivery point: location to deliver commodity or cash settlement.
e) Delivery date: contract to terminate)
Con’t
• Commodities for Futures Trading
• Commodities permissible under futures trading must satisfy the following
conditions.
• Plentiful supply of the commodity. 
• Must be storable.
• Commodity should be homogeneous. 
• Commodity should have a large demand. 
• Supply of the commodity should not be controlled by a few large firms. 
• The price of a commodity should be liable to fluctuate over a wide range.
 
• Used to specify:
a) The seller to deliver a commodity to a specified future time.
b) An obligation of the buyer to pay a fixed price.
c) Buyers pick up the commodity at the pre-specified point-of-delivery.
d) An expiration date (time of delivery).
e) Other standardized measures and dates.
Futures market controversies
Pros and Cons of future market
Pros
Easy pricing
High liquidity
Risk hedging
Cons
No control over future events
Price fluctuation
6.6. Futures market controversies
Pros and Cons of future market
Pros
Easy pricing
High liquidity
Risk hedging
Cons
No control over future events
Price fluctuation
Potential reduction of asset prices
Con’t
• Forward Markets
• A market in which the purchase and sale of a commodity takes place at time ‘t’ but the
exchange of the commodity takes place on some specified date in future i.e. t+1.
• Sometimes even on the specified date in the future, (t+1) there may not be any
exchange of the commodity.
• the differences in the purchase and sale price are paid or taken.
• Services Rendered by a Forward Market.
• Reduces price fluctuations so that the margin of profit may be small. 
• Ensures an even flow of goods, avoiding gluts in the peak season, and shortages in the
slack seasons.
• It brings about an integration of the price structure of commodities at different points
of time.
• Facilitates large purchases and sales at a short notice.
• Brings coordination of the current and future expectations by rotating in the light of
changing supply – demand situation.
Con’t
• Dangers of Forward Market
• Forward market opens out the way for a large number of persons with
insufficient means, inadequate experience and information to enter into
commitments which may be beyond their means. In such conditions
market gets demoralized.
• It enable unscrupulous speculators, with little interest in the actual supply
and demand for, a particular commodity, to corner the supplies and
organize bear raids and bull raids on the market in the hope of making easy
money for themselves. This results in violent fluctuations in prices.
2. Forward Contracts
An agreement between two parties (counterparties) for the delivery of a physical
asset (e.g., oil or gold) at a certain time in the future for a certain price that is fixed
at the inception of the contract.
customized to accommodate any commodity, in any quantity, for delivery at any
point in the future, at any place.
6.4. Hedging with Futures
A risk-management tool for both producers and users of commodity
products.
Buying or selling futures contracts as protection against the risk of loss due
to changing prices in the cash markets.
A risk-management tool for the producer.
If you have a crop of livestock to market, you want to protect yourself
against falling prices in the cash markets.
If you need to buy feed or feeder cattle, you want to protect yourself against
rising prices in the cash markets.
 Options on futures contracts
Traded at futures exchanges too.
An option is the right, but not obligation, to buy or sell a futures contract at
a specified price.
You pay a premium when you buy an option, and you pay a commission to
the broker.
For example, if you buy a put option and prices rise, you can let the option
expire and sell in the cash markets at a higher price.
If prices fall, you can protect yourself against the low cash price by:
Offsetting the option (sell the same type of option).
Exercising the option (exchange the option for the underlying futures
contract).