Definition

A market is an arena for organizing and facilitation business activities.

Define a market– Form What

– Place Where

– TimeWhen

– Institutional level Who

Examples

Iowa-Southern Minnesota

Hog carcasses 185 pound, 51-52%

lean Plant delivered January 10, 2003

Boneless pork loins

– Farmland

– Hormel Hy-Vee meat

department Ames, Iowa January 10, 2003

Cash or Spot Market

When: Immediate ore near-term delivery What: Commodities

– Defined by minimum standards– Often set by USDA

Where: Typically at buyer’s location– Elevator, processor, auction

Who: Depends on level– Farmer-first handler-processor-wholesaler-

retailer

Cash or Spot Market #2 yellow corn, Heartland Coop at Nevada, January

5, 2004, farmer to first handler. #1 yellow soybeans, north central Iowa elevators,

January 5, 2004, farmer to first handler. Fed cattle 65-80% Choice, Nebraska feedlots,

January 7, 2004, feedlot to packer Iowa-S. Minnesota 51-52% Lean hogs, plant

delivered, January 7, 2004, farmer to packer. Medium-Large Frame steers 600-650 pounds,

Dunlap Iowa Auction, January 3, 2004, cowherds to feedlots.

Futures markets

Today’s price for products to be delivered in the future.

A mechanism of trading promises of future commodity deliveries among traders.

Biological nature of ag production– Prices not known when production decision is

made– Processors need year around supply

Futures Market Exchanges

12 organized exchanges Two largest

– Chicago Board of Trade (CBOT)» Grains, interest rates» http://www.cbot.com/

– Chicago Mercantile Exchange (CME)» Livestock, financial, currencies» http://www.cme.com/

– Combined for 75% of futures volume

Semester long assignment

Choose and follow a commodity each week throughout the semester.

Due each Tuesday– Brief (less than one page) analysis of factors

that impacted the market the previous Monday – Friday

– Calculate your margin account based on Friday’s close.

Sources for information Links also on class web site Cash

– http://www.ams.usda.gov/lsg/mncs/index.htm– http://www.extension.iastate.edu/cgi-bin/Notes/

rnoteindex.pl?COMMODITY Futures

– http://www.cme.com/– http://www.cbot.com/

Analysis– http://www.econ.iastate.edu/outreach/agriculture/

periodicals/ifo/– http://www.agribiz.com/merchdiz/analysis.html

Due Tuesday Jan 20

Pick a commodity Define the cash market and report the

price. Find and report the futures price for the

same commodity for Friday.– Choose a contract month that expires after the

end of the class.– July or later for corn, wheat, or soybeans– June or later for cattle, feeder cattle and hogs

Futures Market Exchanges

Trading pits Centralized pricing

– Buyers and sellers represented– All information represented

Perfectly competitive market– Open out-cry trading

The futures contract

A legally binding contract to make or take delivery of the commodity– Form (wt, grade, specifications)– Time (delivery date)– Place (delivery location)– Possession (seller delivers, buyer receives)

The futures contract Standardized contract No physical exchange takes place when

the contract is traded. Deliveries are made when the contract

expires (delivery time) Payment is based on the price established

when the contract was initially traded.

Standardized contract Certain delivery (contract) months Fixed size of contract

– Grains 5,000 bushels– Livestock in pounds

» Lean Hogs 40,000 lbs carcass

» Live Cattle 40,000 lbs live

» Feeder Cattle 50,000 lbs live

Specified delivery points– Relatively few delivery points

Market position

Objective: Buy low, sell high You can either buy or sell initially

– Sell a December Corn contract initially» Short the market» Buy back at a later date

– Buy a February Live Cattle contract initially» Long the market» Sell back at a later date

Margin account Highly leveraged trades

– Margin is the earnest money that must be maintained in the trader’s account

– Often 5-10% of full value Margin account settled everyday

– Must maintain account balance– Margin call

Calculate as if you had to get out of the market every day.

Margin Account Example

Corn Contract– 5,000 bushels @ $2.80 = $14,000– Margin = $500

Cattle contract– 40,000 pounds @ $.70 = $28,000– Margin $1,000

Margin Account

Initial margin: The amount needed to open and account.

Maintenance margin: The minimum amount needed to keep and account open.

“Mark to the Market” at the close of each trading day.

Margin Account Example

Initial margin$1,000

Maintenance margin$800

Corn contract (5000 bushels)– Day 1: Sell at 2.55

Margin Account Example

Day Price Chg G/L Margin

1 2.54 +.01 +50.00 1050.00

2 2.58 -.04 -200.00 850.00

3 2.61 -.03 -150.00 700.00

Below Maintenance Margin

must make $100 margin call 800.00

4 2.52 +.09 +450.00 1250.00

Changes reflect the initial “sell” of the contract

Margin Account Example

Note that you can calculate your margin account if you know the initial margin, any additions or removals and the current closing price.