Hedging in the Produce Industry Research Paper

Download this Research Paper in word format (.doc)

Note: Sample below may appear distorted but all corresponding word document files contain proper formatting

Excerpt from Research Paper:

Thomas Foods: Hedging Strategies

The food industry is extremely risky from the point-of-view of an owner or a supplier. Damage to crops from adverse weather, changes in customers' consumption habits, and issues with suppliers can all thwart attempts to sell the same amount of crops as the year before. Also, food is perishable so issues with the supply chain can likewise have an extremely adverse effect on sales. Common strategies to deal with risk within a supply chain include "raising prices, shutting down factories and shedding less-profitable brands" (Andrejczak 2008). However, there is a limit to the degree to which these measures can truly mitigate risk given that food products often have a very wide array of substitute goods. Also, shutting down various operations may mean that a company is ill-equipped to take advantage of the benefits of a boom the next year, if, for example, there is a bumper crop of strawberries or demand for limes spikes because of trends in cooking. Thus, yet another vital strategy to protect companies from financial damage is hedging through a more formal risk management strategy.

Thomas Foods

"Food makers use hedges to protect against sudden price moves, smoothing out some of the peaks and valleys in the commodities market by managing risk through futures and options. This gives them a better idea what costs they are likely to encounter in the months ahead, crucial to budget planning" (Andrejczak 2008). This paper will summarize how various hedging strategies can support the growth of Thomas Foods, a produce vendor that sells produce purchased from farmers to major grocery retailers across the country. "Food makers have for decades hedged their exposure to price volatility…similar to what the airline industry does with fuel. Southwest Airlines Co. is well-known for its success in holding down costs by making the right bets on oil prices, giving it a big advantage over competitors as oil prices hit record highs" (Andrejczak 2008). Making the correct hedging decisions regarding the costs of produce can be the difference between profitability and insolvency for a company like Thomas.

Hedging and forward contracts

The most common strategy for food companies include "entering into long-term forward contracts for physical delivery with…suppliers…To protect against price fluctuations, a food company will buy a futures or options contract" (Andrejczak 2008). This effectively allows the company to 'lock into' a particular price, based upon past patterns in demand and allows for a more effective and measured pricing approach. Of course, the detriment of this policy is that if prices become more advantageous, the food company may lose out on the potential for more profits. Furthermore, given that the prices of food have been in such a determinedly upward spiral, it is also possible that suppliers may be reluctant to enter into such arrangements at all, given the fact that market trends seem to be determinedly upward.

This type of hedging can be accomplished by hedging in the futures market and forward contracting. "Both types of contracts allow producers to buy or sell a specific crop at a specific time at a given price" (Contracts, 2014, Agriculture and Agri-Food Canada). In the case of hedging in the futures market, "producers protect themselves from price risk, but remain exposed to basis risk. With forward contracting, producers secure a price for their crop prior to harvest and eliminate both price and basis risk" (Contracts, 2014, Agriculture and Agri-Food Canada). Basis risk is "the risk that offsetting investments in a hedging strategy will not experience price changes in entirely opposite directions from each other. This imperfect correlation between the two investments creates the potential for excess gains or losses in a hedging strategy, thus adding risk to the position" (Definition of basis risk, 2014, Investopedia). Thus, with forward contracting there is the danger that risk may actually be exacerbated rather than mitigated (the risk for excess profits, of course, is also present, as well as excess losses).

Futures contracts "have clearing houses that guarantee the transactions, which drastically lowers the probability of default to almost never. Futures contracts are marked to market daily, which means that daily changes are settled day-by-day until the end of the contract. Settlement can occur over a range of dates" (Contracts, 2014, Agriculture and Agri-Food Canada). In contrast, forward contracts have a single settlement…[continue]

Cite This Research Paper:

"Hedging In The Produce Industry" (2014, July 06) Retrieved December 9, 2016, from http://www.paperdue.com/essay/hedging-in-the-produce-industry-190325

"Hedging In The Produce Industry" 06 July 2014. Web.9 December. 2016. <http://www.paperdue.com/essay/hedging-in-the-produce-industry-190325>

"Hedging In The Produce Industry", 06 July 2014, Accessed.9 December. 2016, http://www.paperdue.com/essay/hedging-in-the-produce-industry-190325

Other Documents Pertaining To This Topic

  • Hedge Fund Regulation the Purpose

    In the first-round survey, a majority of investors cited diversification as their main objective in allocating to hedge funds. Among the second-round interviewees who were planning to increase their target allocations by 10% or more, half named diversification as the motivating factor. Among the approximately one in ten who were planning to decrease allocations by at least 10%, concern with a lack of transparency was the most frequently cited

  • Hedge Fund Management Technique the

    2.3: Theme I: This study's first theme defines hedge funds and presents a synopsis of their history. 2.4: Theme 2: Ways hedge funds compare to mutual funds are noted in this section, this study's second theme. 2.5: Theme 3: segment denotes techniques hedge funds utilise in investing. 2.6: Theme 4: A number of ways rising and falling markets impact hedge funds, this section's theme links to the thesis statement for this thesis/Capstone. 2.7: Analysis:

  • Industry Analysis Since the Passage

    This is significant, because it shows how in the next three years, the airlines are going to face increasing amounts of competition, in a number of different markets. This is because the industry is targeting the same demographics of business and leisure travelers. As a result, the increased amounts of deregulation, will affect the industry in the future, as increased amounts of competition will more than likely mean lower

  • Risk Management in British Hedge Funds

    Risk Management in Hedge Funds A research of how dissimilar hedge fund managers identify and achieve risk The most vital lesson in expressions of Hedge Fund Management comes from the inadequate name of this kind

  • Performance Evaluation of How Hedge

    As a consequence, investors may suffer. Importance of the Study It is necessary and pertinent to discuss the importance of any study, and this particular study is important to many people across many countries. Not only does it have importance for people who are trusting people with their pension and hedge funds in Germany, but it also has importance for people who are considering a career working with these funds and

  • Hedge Funds Suitable for Retail

    Unfortunately, determining which fund to go with for a retail investor is difficult, as there are many unscrupulous fund managers who might seek to take advantage of the fact that they are playing with other people's money and making (at least) the management fee. This can lead even scrupulous hedge fund managers to take unnecessary risks. The danger of hedge funds being mismanaged truly cannot be overstated. For example, Bernie

  • Hedging and Its Importance to the Securities

    Hedging and Its Importance to the Securities Markets In simple terms, hedging is a form of insurance. It is a mechanism used to help shield investors and companies from the negative occurrences within the ordinary business environment. If properly hedged, when negative events do affect a business or individual, the damages incurred will be significantly less. A common example is that of insurance on an automobile or house. In the


Read Full Research Paper
Copyright 2016 . All Rights Reserved