Futures contracts are utilized for hedging to protect against price fluctuations, especially for businesses reliant on raw materials.
Understanding Hedging with Futures
Hedging with futures contracts allows companies to mitigate the risk associated with price volatility. Here's how it works:
-
Price Protection: Companies enter into futures contracts to lock in a specific price for a commodity they will need in the future.
-
Mitigating Price Increases: According to provided information, companies heavily reliant on raw materials, such as food manufacturers and energy providers, use futures contracts to hedge against potential price increases in raw materials, which can significantly impact their production costs.
- Example: A bakery anticipating a rise in wheat prices can purchase wheat futures contracts. If the price of wheat increases, the profit from the futures contract can offset the higher cost of buying wheat on the spot market.
Practical Application:
| Scenario | Hedging Action | Outcome |
|---|---|---|
| Food Manufacturer expects rising corn prices | Buys corn futures contracts | Protects against increased corn costs; profits from futures offset higher expenses. |
| Energy Provider anticipates rising oil prices | Buys crude oil futures contracts | Shields against rising oil prices; futures profits cover the increased cost of oil. |
By using futures, these companies can stabilize their costs, improve their budget predictability and protect their profit margins from the volatile market.
