What Is a Minimum Price Contract?
A minimum value contract is a forward contract that guarantees the seller a minimum value at provide. This kind of affiliation is used with commodities to give protection to producers from value fluctuations to be had available in the market. Minimum value contracts aren’t odd in agricultural product sales, for instance, the sale of grain.
A minimum value is typically specified because of agricultural products can wreck and lose all or part of their value if not dispensed promptly.
Key Takeaways:
- A minimum value contract is a forward that accommodates a confident value floor upon provide of the underlying asset.
- This kind of affiliation is most no longer odd for agricultural derivatives, as most of these commodities are liable to spoilage, which is in a position to erode their market value.
- A minimum value contract will specify the fitting quantity, minimum value, and provide period for the specified underlying commodity.
Figuring out a Minimum Price Contract
A minimum value contract allows a producer of agricultural products to get to the bottom of how so much of their product they wish to store and the volume they wish to unload to make deliveries and acquire an acceptable value for their products.
A minimum value contract has language that specifies the availability details, along side the correct amount and top of the range of the commodity to be delivered, its minimum value, and what the availability period for the specified underlying it is going to be. One receive advantages to the seller is {{that a}} minimum value contract typically specifies a period during which the seller would most likely come to a decision to advertise the product at a price above the set minimum to make the most of higher market fees. In this method, minimum value contracts come with a provision very similar to a put selection in numerous types of shopping for and promoting.
Provide is the overall degree of a minimum value contract. The price and maturity are set on the transaction date. As quickly because the maturity date is reached, the seller is had to each send the commodity if the transaction has not however been closed out or reversed with an offsetting selection.
Example of a Minimum Price Contract
A soybean grower would most likely decide to advertise 100 bushels of soybeans to Company A in June. The cash delivered value for the ones bushels is $6.00. Throughout the contract, the grower specifies a December identify, with a choice value of $8.00. As part of the minimum value contract, the grower may additionally pay a $.50 most sensible charge consistent with bushel and a $.05 provider rate.Â
The contract calculation is the cash delivered value minus the highest charge and the provider rate. In this example, the confident minimum value consistent with bushel is $5.45 ($6.00 – $.55=$5.45).
In December, if the price of soybeans has risen to $9.00, the $8.00 identify is now worth $1.00, or the difference between the two numbers. That $1.00 is added to the minimum value, giving an entire confident value to the grower of $6.45 consistent with bushel. This is $1.00 above the minimum value confident by way of the contract.
Another chance is that right through December, the price of soybeans can have most effective risen to $7.00. In this fit, the verdict selection isn’t worth anything, since the futures value has turned into out to be underneath the verdict value. So, the grower receives the minimum value of $5.45.
In this second situation, the downside of the contract is apparent. The seller has paid a $.50 most sensible charge and a $.05 provider rate for a choice selection that did not get them a better value for their crop. They’re going to have made a greater receive advantages underneath a contract without the ones fees.
