What Is a Legacy Hedge?
A legacy hedge is a long-term hedge position, eternally a futures contract, that a company has held for an extended period of time. Commodity companies eternally hang legacy hedges on their reserves to give protection to against opposed movements in the price of the commodities that they produce or eat.
A legacy hedge will eternally be put in place by means of an entity that expects the type of likelihood covered by means of the hedge to be kind of power or suitable throughout its lifestyles.
Key Takeaways
- A legacy hedge is a hedge that has existed for a long time and is predicted to persist into the long term.
- Legacy hedges are used by commodity-related companies to make sure a price for a product that they expect to shop for or advertise for the life of its operations.
- A legacy hedge most often might not be taken off apart from something fundamental changes or else if the entity holding the hedge position goes into chapter 11.
Understanding Legacy Hedges
A legacy hedge is a way for a commodity company to make sure a return on the sale of a commodity far into the long term. Some commodities, akin to grease or valuable metals, revel in not unusual shifts in market worth.
To stabilize their source of revenue streams, they will hedge in opposition to price volatility by means of signing a futures contract, an agreement to advertise a commodity on a specified date at a specified worth. They effectively lock throughout the spot worth of the commodity at the time they sign the contract.
For the amount of the commodity throughout the legacy hedge, the company has given up any imaginable certain sides from a price build up in industry for cover against imaginable losses from a price drop.
While the commodity company would welcome the extra source of revenue from rising prices, confident reimbursement may be additional valuable as it shall we within the company to make keep an eye on alternatives consistent with a cast long run income drift.
Professionals and Cons of Legacy Hedges
Any hedge position can decrease every techniques. If the spot worth has larger by the time the futures contract expires, the company will in any case finally end up selling the commodity beneath the existing market value. If the spot worth has lowered, the company it is going to be selling above market value.
As a long-held hedge position, a legacy hedge will have a specifically dramatic stabilizing, particularly if a fundamental shift in market forces affecting the commodity occurs throughout the period in-between.
For example, any gold producer who signed a 10-year futures contract in 2001, locked throughout the spot worth when gold used to be as soon as purchasing and promoting at less than $300 in line with troy ounce. Previous than the contract expired, the US housing market crashed and the global monetary machine suffered the Great Recession.
The price of gold skyrocketed since the stock market collapsed and faith in the US dollar faltered internationally. In 2011, when the contract would have expired, gold prices climbed as top as $1,889.70 in line with troy ounce. Any gold tied up throughout the futures contract did not send to the gold producer the benefit of the more than 500% build up in worth over the 10-year period.
While gold prices have since long gone up and down, at more than $1,724 in line with troy ounce as of March 12, 2021, they remain significantly higher than pre-Great Recession prices, so any gold producer nevertheless sitting on legacy hedges established previous than gold prices shifted upward is sitting on losses.
