Market Risk, Speculation, and Hedging

The assumption of risk is an important function that must be performed by all types of middlemen, manufacturers, and original producers in the agricultural and extractive industries. In addition, there are numerous specialists in risk bearing, known as speculators. A number of types of risk which are of especial interest to those engaged in marketing are considered in this chapter. Major emphasis is placed upon the risks which arise out of changing market conditions and the methods whereby such risks may be minimized or shifted to others.

Classification of Market Risks

Market risks may be classified according to their cause or character into five groups, as follows:

1. Physical destruction or deterioration of commodities or other properties which may result from natural causes such as windstorms, floods, earthquakes, drought, or unseasonably cold or hot weather, or from controllable causes such as inadequate safeguards against fire, vermin, or freezing

2. Theft, including fraud or pilferage by employees, burglary, or shoplifting

3. Personal contingencies relating to accident or sickness of employees, death of key executives, or, especially in small companies, of key salesmen who account for a large proportion of a firm's sales volume

4. Credit extensions which involve the risk that debtors may be unwilling or unable to meet their obligations at maturity or ultimately

5. Market conditions which involve risks arising out of uncertainty about the exchange value of commodities

Of these classes, the most significant risks are those which arise out of market conditions. They may be divided principally into time risks and place risks. Practically all marketing transactions involve a certain degree of hazard due to changes wrought by the passage of time. Merchants buy goods with the hope of reselling them at a profit; manufacturers attempt to make products that will sell at remunerative prices; farmers raise what they think will be in demand. But markets for certain commodities may be glutted; the wants of consumers may change; or seasonal changes may be too slow or otherwise unfavorable. Any of these changes may affect the demand for and supply of any commodity one way or another, with a resulting increase or decrease in risk. Place risks are great when a commodity is offered for sale, or a purchase must be made, in an unfavorable market. Special losses may result from misjudging markets. This is often true of perishable fruits and vegetables when, because of a lack of adequate information on the part of shippers, they are forwarded to a glutted market where they must be sold without delay to prevent physical deterioration.