Question - A wheat farmer wanted to protect himself from fluctuations in prices of the commodity.

Is there any such instrument in financial market which can protect him from fluctuations, if yes explain
how the farmer would be benefitted using an example.
Answer
Commodity prices are highly unstable in recent years. ue to this there is an increased interest in
forward selling by the formers. !here was a traditional approach that most formers hang around until
their crops and li"e stock ha"e been produced and are all set to be deli"ered before selling. ue to
commerciali#ation of agriculture has created "ital changes in agricultural. $y setting up returns at the
time resources are dedicated to production, forward selling enables formers to condense their co"erage
to price risk.
In future market, Formers use forward contract to beat the price variation. !here are few dangers
in forward selling. !he most serious is that crop failure might force a culti"ator to buy his way out of a
forward contract at a loss. !herefore, when har"est risks are si#eable, as they often are in farming,
forward sales should be restricted and not all of the anticipated output.
Steps which former should keep in mind.
%tep &- Categori#e the choices a"ailable for production and contracting.
%tep ' Calculate approximately (roduction cost.
%tep ) Calculate approximately potential returns based on forward price and expected price le"els.
%tep * Assess output risk.
%tep + Assess basis risk if potential contract are drawn in.
%tep , Assess credit risk of the buyers if cash forward contract are drawn in - pose for financing of
potential margin calls if futures contracts are occupied.
%tep . Contract for inputs and outputs and take out production map.
%tep / 0ine-tune forward sales and purchases to obtain ad"antages of new information about price
forecast, if and when appropriate, for the period of the production procedure.
Example -
A farmer who produces wheat wishes to lock in the price that farmer will put up for sale next season1s
har"est. A baker also wants to guard the price that they will bestow for the wheat so that they 2baker3
can work out their fabrication capability and potential earnings. It profits for both the farmer and the
baker to work out a futures contract to agreement the deli"ery of a definite 4uantity of wheat at a fixed
point in the future for a fixed "alue. !hey 20armer and $aker3 secure the price that they be of the same
opinion will be fair at the deli"ery point in time. It is the futures contract not the actual produce that is
traded on the futures market.
!he two parties in a futures agreement are referred to by di"erse terms. !he party 2the farmer in the
scenario abo"e3 that agrees to sell and deli"er the product 2commodity3 is known as the short
position. !he party 2the baker in this scenario3 agrees to ac4uire and take deli"ery of the commodity is
well-known as the long position. 5ach futures con"ention will ha"e a short and long spot. !his
terminology is used in the section dealing with strategies. A futures contract will indicate all aspects of
the transaction 2contract3. !his includes the 4uantity of the commodity that is being traded, the price per
unit, the deli"ery date, the 4uality of the commodity and the method how it will be deli"ered. !he futures
contract has a 6price7 and this is the price that the parties consent upon for the price of the commodity
or financial instrument to be deli"ered. If the farmer and the baker enter an agreement for &8,888
bushels of granule for rupee + per bushel, then this will be the 6price7 of the agreement.
Question - A company had o"ercome the risky stage and ha"e also recorded profits but needed
financial support as they could not raise capital through public issue. %uggest the different stages at
which finance can be pro"ided to the established firm and by whom.
Answer: - As company recorded the profits, but as declaration overcome from some risky phase. So due to this
reason company could not raise that much required money in initial public offer. Company can use any below
instrument to raise money as an when required. But at the time of fund raising companies should take care
various attributes.
9enture Capital 0unding
Angel In"estor
Commercial papers
0unding using warrants
$orrowing:;oan 2from (ri"ate firm or <o"ernment firm3
Corporate Funding
Corporate funding:-
As company is doing good but due to some factor could not raise money in initial public offer so it can
go for corporate funding. !here are so many corporate houses which helps the organi#ation in those
scenarios. Corporate houses looks at past track record, "ision, mission, policies and "alues of the
company. $ecause of risky stage company could not raise money. %o for expansion they can get
money from big corporate houses. Corporate house pro"ide money on "ery nominal interest rate.
enture Capital funding:-
Company can approach to "enture capitals for funding. !here are so many "enture capitals which help
companies to mo"e on by pro"ing money. 9enture capitalist helps most of the startup firms.
0lipcart is best example who has raised a lot of money from "enture capitals but they ha"e shown their
growth to "enture capitalist. =ere "enture capitalist take shares of that company by pro"iding money to
company.
Funding using warrants:-
Company1s board can use of one of the financial instrument names warrants. It is a contractual financial
instrument allows the holder special rights to buy securities. $y using warrants company can raise fund.
>arrants are for longer period term. !here are "arious type of warrants, company can look at their
needs and go for that type of warrant.
!ebt financing- organi#ation can also raise fund by debt financing, it1s nothing it1s also a kind of loan
offered by bank and go"ernment agencies to help in setting up new business.
"orrowing#$oan %from &rivate firm or 'overnment firm(
Company can raise fund by borrowing from foreign banks as interest rate are "ery less as compared to
India. ?any big companies are raising money by this process. 0ew <o"ernments also pro"ide loans to
pri"ate sector companies but that company should be known.
&rivate Stock )fferings: If the company is not a behemoth it can go for pri"ate stock offering for
raising capital. (ri"ate stock offerings are also commonly known as pri"ate placement. !he company
can use pri"ate placement method to sell securities of its business to wealthy indi"idual2s3 or
organi#ations without an Initial (ublic @ffer. !he organi#ations which get in"ol"ed in pri"ate placements
may include insurance companies, large banks, pension funds and mutual funds. Also as the company
has o"ercome the risky stage and has recorded profits, so it stands good chance to raise capital
through pri"ate placements. !he other ad"antages of raising capital through pri"ate stock offerings areA
&. It is simple, fast, painless and inexpensi"e as compared to I(@.
'. Bnderwriting companies are not re4uired.
Commercial papers: company can launch their commercial paper to raise the capital, commercial
papers are the one which are for short term and maximum life is '.8 days and it1s always sold on
discounted rate. !hese are "ery helpful in raising capital in short term, these always gi"en at
discounted rate- means the always gi"en on less "alue then they actual worth. !hese are like ! bills but
these are issued by corporate instead of go"ernment.
*ngel Investor: - !here are angel in"estors which are "ery rich people and they want to in"est their
money to make some profit, company can reach these people and share details of company. Company
track records, company policies, company future plan and road map for upcoming few years. !hey
need to create interest of these people in company profile. !hese people are willing to in"est but they
always wanted to in"est in some good proCect. %o, we need to con"ince them in"esting in this company
is worth and they will get good results.