COMMODITIES FUTURES MARKET: COFFEE

This research examines the commodities futures market in coffee. The functioning of the futures market in coffee, together with commodities contracts is explained. Hedging strategies for participants in the coffee futures market are discussed, and the significance of hedging techniques to bulk coffee traders is reviewed.

Functioning of the Futures Market in Coffee, and Commodities Contracts

The coffee trader relies on fundamental information about current crop and demand prospects (International Trade Forum, 1991, p. 20). Positions of big traders in the market are published publicly on a monthly basis. Trading in a commodity is suspended when the market becomes too volatile, and limits are placed on speculative positions (Gould, 1988, p. 25). The majority of the trading volume in coffee results from hedging. Hedgers use the coffee futures market primarily to manage risk (Gould, 1988, p. 25).

A futures contract is a legally binding agreement for the delivery and acceptance of a specific commodity at a specific time and place in the future (Gould, 1988, p. 93). Cash price "forms an effective floor and ceiling to the futures contract price and the two will be very nearly the same in the expiration month of the contract" (Gould, 1988, p. 138).

The coffee futures market has been both volatile and generally depressed since the International Coffee Agreement between producing and consuming countries collapsed in 1989 (Schap, 1989, p. 22

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sis of dollar values) to the cash position in the market. Thus, a trader's long position in cash must be offset with a short position in futures. A second procedure is the conversion factor method. The conversion factor method adjusts the invoice amount covering the required delivery of commodities on a futures contract for the difference between the discount rate at which the commodity will be delivered and the discount rate specified in the futures contract (Toevs and Jacob, 1986, p. 62). The equation for the determination of the hedging ratio using this method is as follows: N = Covariance (Change I with Change F)/Variance Change F, where: N = the number of future contracts which must be sold; I = the cash commodity; and F = the futures commodity. A third procedure is the regression for price changes method. In the regression for price changes method, a representative series of data are required for daily cash price changes in the cash commodity and the futures contract (Toevs and Jacob, 1986, p. 62). Regression analysis is applied to these data to determine the best fitting straight line, or linear relationship. The regr

Category: Economics - C