AH1 Price and Production Risk

Domestic and world wheat trade with a future on each. A grower and a miller hold opposite exposures.

Objective

Protect the value of the position against price and production risk over two periods. Assessed on profit and loss.

What it shows

• Hedging a commodity with a future when the exposure is real.
• The grower and the miller as natural counterparties.
• Domestic and world prices that move together but not one for one.

Watch out for

• Hedging with the world future when the exposure is domestic.
• A hedge that removes price risk and leaves production risk.
• A counterparty who is hedging the other way, so the price moves on the hedges.

Who takes part

• Grower — half the class. Holds 2,000 domestic wheat, WHEAT.
• Miller — the other half. Starts short 2,000 domestic wheat, the position a miller has to cover.
• Both can trade WHEATF, the domestic future, and WWORLD and WWORLDF, world wheat and its future.

Class size

Twelve to forty students, split evenly between the two roles. The futures need both sides.