1. Based on the expectation of higher prices. 2. To establish costs, pre-determine selling prices and protect profits on advance sales. ---------------------------------------------------------------------------- Initial | | | Transactions | Subsequent Transactions |Sugar Cost | Result -------------+------+----------+--------+-------+------+------------+------- | |Condition | Price |Result |Price | Figure it | In | |of market | you | of | you | this way |each | | when you | would |selling| pay | |case | |buy actual| obtain | your | for | |the | | sugar |for your|futures|actual| |same | | |futures | |sugar | | -------------+------+----------+--------+-------+------+------------+------- | | | | | |Price paid |Your | | | | | |for actual |sugar | | | |A | |sugar less |cost is You buy Sugar|When |If it has | |profit | |hedging |6.00 Futures at |you |advanced | |of | |profit |as pre- 6.00 to cover|buy |to 8.00 | 8.00 |2.00 | 8.00 |8-2=6 |deter- future |actual| | | | | |mined requirements;|sugar,| | |A | |Price paid | fix your |you |If it has | |loss | |for actual | price and |sell |declined | |of | |sugar plus | take orders |your |to | | | |hedging loss| on the basis |fu- |4.00 | 4.00 |2.00 | 4.00 |4+2=6 | of 6¢ sugar |tures | | | | | | | |If it is | |No | | | | |still at | |profit,| | | | |6.00 | 6.00 |no loss| 6.00 | 6.00 | -------------+------+----------+--------+-------+------+------------+------- It is equally clear that if a manufacturer names a price and takes advance orders without pre-determining his sugar cost, his profit is a matter of guesswork. He is not going to know the cost of his manufactured product until he buys his sugar. Assume that you have contracted to deliver sugar to a manufacturer or to any customer at a definite date and a specified price, without buying sugar to cover your requirements. If the price of sugar is favorable when you deliver it, you are fortunate and net a profit. But sugar may have advanced to a point where you are forced to pay such a price that your profit is lower than it should be. In fact there may not be any profit at all.