Futures Market Explained


– [Voiceover] A three-dollar
box of corn cereal stays at roughly the same price day-to-day and week-to-week. But corn prices can change daily. Sometimes by a few cents, sometimes by a lot more. Why does the cost of processed food generally stay quite stable, even though the crops that go into them have prices that fluctuate? It’s partly thanks to the futures market. The futures market allows
the people who sell and buy large quantities of corn to insulate you, a consumer, from those changes without going out of business themself. Let’s meet our corn producer, this farmer. Of course, she is always
looking to sell her corn at a high price. And on the other side, our corn user, this cereal company, is always looking to
buy corn at a low price. Now, the farmer has a
little bit of a problem, because her whole crop
gets harvested at once. Lots and lots of farmers will be harvesting at the same time, and the huge supply can
send the price falling. And even though that
price might be appealing to the company that
makes cereal from corn, it doesn’t want to purchase
all of its corn at once, because, among other reasons, it would have to pay to store it. (cash register rings) But it’s fortunate that
corn can be stored, because that means it
can be sold and bought throughout the year. And this is where the
futures market fits in. Buyers and sellers move bushels around in the market, though actual corn rarely changes hands. Instead of buying and selling corn, the farmer and cereal maker
buy and sell contracts. Now we are getting closer to
peace of mind for both sides, because a futures
contract provides a hedge against a change in the price. This way, neither side is stuck with only whatever the market price is when they want to buy or sell. These contracts can be made at any time, even before the farmer plants the corn. She’ll use the futures market to sell some of her anticipated crop on a certain day in the future. Of course, she’s not going to sell all of her corn on that contract. Just enough corn to reassure her that a low price at harvest won’t ruin her business. The contract provides that security. The cereal company uses the same market to buy bushels. Their contract protects
against a high price later. Contracts will gain or lose
money in the futures market. If the price goes high, the farmer loses money
on that futures contract. Because she’s stuck with it. But that’s okay, because now she can sell
the rest of her corn, what wasn’t in that contract, at the higher price that offsets her loss
in the futures market. If, at harvest time, the
price of corn is low, well, that’s exactly why she
entered the futures market. The low price means her
contract makes money. So that profit shields her from the sting of the low price she’ll get for the bushels she sells now. A corn cereal company doesn’t
like those higher prices, and that’s why they
have a futures contract. They make money on it and can use that profit to cover the higher price of the corn they now need to buy. The futures market serves
as a risk management tool. It doesn’t maximize profit, instead, it focuses on balance, and in this way it keeps your cereal from breaking your weekly shopping budget.

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