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Thomas Foods -- Hedging Strategies
If Thomas Foods expects to protect itself against suddenly rising prices that farmers charge for their produce -- due to crop failures, inclement weather, or other unexpected events -- then Thomas Foods needs to engage in some form of a hedging strategy. There are a number of ways to do this, and this paper will point to several strategies and models that might work for Thomas Foods. At a minimum, the comptroller at Thomas Foods should be knowledgeable about ways to protect his company from suddenly skyrocketing produce prices
What are "futures"? The available literature on ways to protect a company like Thomas Foods from suddenly being stuck with prices from farmers that are well above what was understood at the outset of the contract -- is to buy futures. A future is a financial deal signed as a contract that obligates the "…buyer to purchase an asset (or the seller to sell an asset)" such as produce from farmers at a "predetermined future date and price," according to investopedia.com. For example, say a farmer is producing corn; that farmer could use futures to "lock in a certain price" for his corn, and hence reduce the risk, or hedge the risk against falling...
Thomas Foods could also buy futures to lock in the price it pays the farmer for corn.
What are "options"? In many cases, options pertain to the stock market; an investor engages in a securities contract, a "call" or a "put" that gives the investor the right to either buy ("call") or sell ("put") an asset (or an equity) at a "predetermined price" (called the "strike price") at a predetermined window of time (with an understood "expiration date") (investorplace.com). The "calls" offer the buyer (in this case, Thomas Foods) the right, "but not the obligation," to buy a product or asset at a specified price in a certain window of time (investorplace.com). On the other hand, the "puts" offer the purchaser the right (but again, not the obligation) to sell a product or asset. The "put" would be on the farmer's end; the "call" would be done by Thomas Foods.
What is a "forward contract"? This is a private contract between say, Thomas Foods and a farmer; Thomas Foods agrees to buy and the farmer agrees to sell a "specific quantity" of produce at a price indicated in the contract (finweb.com). For example, before planting his strawberries, the…
Works Cited
Financial Web. (2012). Forward and Futures Contracts -- Part 1: Forward Contracts.
Retrieved August 3, 2014, from http://www.finweb.com.
Investing Answers. (2011). Spot Market. Retrieved August 3, 2014, from http://www.investinganswers.com.
Investopedia.com. (2011). Futures / Definition of 'Futures' Retrieved August 3, 2014, from http://www.investopedia.com.
2014, from http://www.investorplace.com.
Hedges. Retrieved August 3, 2014, from http://www.cba.uah.edu.
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