AFM Agricultural Marketing & Commodity Markets 2 — Questions and Answers
Question 1: A corn farmer who sells corn futures contracts to protect against a price decline before harvest is executing a:
- Long hedge
- Speculative long position
- Short hedge (Correct answer)
- Inter-commodity spread
Correct answer: Short hedge
A short hedge involves selling futures contracts to establish a price floor, protecting a producer who owns or expects to own the physical commodity against declining prices.
Question 2: When the basis is described as 'stronger than expected,' this means:
- Cash prices fell more sharply than futures prices during the period
- Cash prices rose relative to futures prices, making the basis less negative (Correct answer)
- Futures prices increased more rapidly than local cash prices
- Both cash and futures prices declined by exactly the same amount
Correct answer: Cash prices rose relative to futures prices, making the basis less negative
A strengthening basis means the cash price improved relative to the futures price (basis = cash minus futures became less negative or more positive), which is favorable for short hedgers.
Question 3: A basis contract benefits a grain producer primarily by:
- Locking in both the cash price and futures price simultaneously at signing
- Fixing the basis level while leaving the futures price component open for later pricing (Correct answer)
- Guaranteeing delivery obligations without specifying any price terms
- Transferring commodity title to the elevator immediately while deferring payment
Correct answer: Fixing the basis level while leaving the futures price component open for later pricing
A basis contract establishes the basis at contract signing while allowing the producer to set or 'price' the futures component later when futures prices are more favorable.
Question 4: A put option in agricultural markets gives the buyer the right to:
- Purchase a futures contract at the specified strike price
- Sell a futures contract at the specified strike price (Correct answer)
- Obligate the seller to accept grain delivery at the current market price
- Lock in a specific basis level for a future grain delivery
Correct answer: Sell a futures contract at the specified strike price
A put option gives the holder the right, but not the obligation, to sell a futures contract at the strike price before expiration, providing price floor protection for producers.
Question 5: Local cash grain prices at a country elevator are primarily determined by:
- Federal loan rates and price support levels established by farm legislation
- The relevant futures market price adjusted for the local basis (Correct answer)
- The average cost of production for farmers in the surrounding county
- Weekly export sales figures reported by the USDA Foreign Agricultural Service
Correct answer: The relevant futures market price adjusted for the local basis
Local cash prices are derived by taking the nearby futures price and adjusting it by the local basis, which accounts for transportation, local supply and demand, and handling costs.
Question 6: In commodity markets, 'full carry' refers to:
- The physical trucking cost of moving grain from the farm to a terminal elevator
- The total cost of storing a commodity, including interest, storage fees, and insurance (Correct answer)
- The markup charged by a grain elevator above the futures price for handling
- The rail transportation rate from a country elevator to an export terminal
Correct answer: The total cost of storing a commodity, including interest, storage fees, and insurance
Full carry represents the complete cost of holding a commodity in storage over time, encompassing interest on tied-up capital, physical storage charges, and insurance premiums.
Question 7: 'Convergence' in futures markets describes the phenomenon where:
- Multiple commodity exchanges adopt identical contract specifications
- Cash and futures prices come together as a futures contract approaches its expiration (Correct answer)
- Domestic and international prices for a commodity align through trade flows
- Prices across multiple futures delivery months equalize through spreading activity
Correct answer: Cash and futures prices come together as a futures contract approaches its expiration
As a futures contract reaches its delivery month, arbitrage activity forces cash and futures prices to converge because the futures contract becomes essentially equivalent to a cash transaction.
AFM Agricultural Marketing & Commodity Markets 2
A corn farmer who sells corn futures contracts to protect against a price decline before harvest is executing a: