Futures Price

Definition

The futures price is the predetermined price at which a commodity, financial instrument, or other asset will be bought or sold at a future date. It is a key concept in the context of commodity price risk management, as it allows market participants to lock in a price for a future transaction, mitigating the impact of price fluctuations.

5 Must Know Facts For Your Next Test

1. Futures prices are determined by supply and demand in the futures market, which is distinct from the spot or cash market.
2. Factors that influence futures prices include expected future supply and demand, storage costs, interest rates, and market sentiment.
3. Futures prices can be used to lock in a price for a future purchase or sale, providing price certainty and risk management for commodity producers, processors, and consumers.
4. The difference between the current spot price and the futures price is known as the basis, which reflects the market's assessment of future supply and demand conditions.
5. Futures markets enable price discovery, as the trading of futures contracts helps to establish a benchmark price for the underlying commodity.

Review Questions

• Explain how futures prices are determined in the context of commodity price risk management.
  • Futures prices are determined by the forces of supply and demand in the futures market, which is distinct from the spot or cash market. Factors such as expected future supply and demand, storage costs, interest rates, and market sentiment all influence the futures price. The futures price allows market participants, including commodity producers, processors, and consumers, to lock in a price for a future transaction, enabling them to manage the risk of adverse price movements. This price certainty is a key benefit of using futures contracts to mitigate commodity price risk.
• Describe the relationship between the spot price and the futures price, and explain the concept of basis.
  • The difference between the current spot price and the futures price is known as the basis. The basis reflects the market's assessment of future supply and demand conditions for the underlying commodity. A positive basis indicates that the futures price is higher than the spot price, while a negative basis means the futures price is lower. Monitoring and understanding the basis is important for effective hedging strategies, as it can provide insights into the market's expectations and help traders determine the appropriate futures contract to use for their risk management needs.
• Analyze the role of futures markets in price discovery and how they contribute to the management of commodity price risk.
  • Futures markets play a crucial role in price discovery by providing a platform for the trading of standardized contracts for the future delivery of commodities. The trading of these futures contracts helps to establish a benchmark price for the underlying commodity, which reflects the market's assessment of future supply and demand conditions. This price discovery function is essential for commodity producers, processors, and consumers, as it allows them to make informed decisions and manage their price risk. By using futures contracts, market participants can lock in a price for a future transaction, providing them with price certainty and enabling them to mitigate the impact of adverse price movements. The ability to hedge commodity price risk through the futures market is a key benefit that supports the efficient functioning of the commodity supply chain.

Related terms

Commodity Futures: Standardized contracts that obligate the buyer to purchase and the seller to sell a specific commodity at a predetermined price and future date.

Forward Contract: A customized agreement between two parties to buy or sell an asset at a specified price on a future date.

Hedging: The practice of taking an offsetting position in a related asset to reduce the risk of adverse price movements.