Reviewed by Oct 05, 2020| Updated on
A commercial hedger is a company that uses futures contracts to lock the price of particular goods that it uses to operate its business. A product is excellent, which is required to produce a good or service. A food manufacturer may practice commercial hedging when buying commodities, such as sugar or wheat, or when producing its goods. Manufacturers of electrical components can hedge the copper it uses in production.
A company uses commercial hedging as a means of standardising operating expenses as they seek to monitor commodity price risk and forecast the output costs more accurately. A hedge is like insurance, where an investment helps to reduce an asset's chance of adverse price changes. Commercial hedgers work to control real price risk in futures contracts.
In comparison, those investors who use the futures markets for commodity trading are non-commercial traders. Speculation is the act of trading in an asset or performing a financial transaction which has a significant risk of losing much or all of the initial outlay with the expectation of a substantial profit.
Potential contracts are being used for both speculative and hedging trading. The deals are traded on different exchanges and have a price basis for delivering a specific amount of commodity at a predefined future date.
If the price of copper falls below that of the futures contract, the company will sell its contract at a loss. By taking a loss on the futures market, the firm has been able to minimise its risk against an increase in the cost of raw material.
The electrical wiring company is not forced to take physical delivery of the product when the copper price increases but can sell the futures at a profit on the competitive marketplace.