Commodity Swap
Commodity swap implies that the parties to the contract agree on the following conditions:
•one of the parties is obligated to buy the goods at the second party to the fixed at the moment of signing of the contract price;
•the second side is obliged to buy the goods at the first at a floating rate, as which may be the average stock price for the agreed upon in the contract period.
If the amount of funds calculated on the basis of a fixed price, exceeds the amount calculated on the basis of floating, the difference is paid to the party who buys the goods at a floating rate and receives a fixed, and Vice versa. Iieo game in which wins the one who is able to better predict the future price.
Let us consider the mechanism of action of Commodity Swap on a concrete example.
The plant sells its products on the market at market prices.
In order to hedge the risk of changes in prices of products, plant negotiating with the Bank about the following commodity swaps:
•the goods : aluminum;
•amount of the agreement is calculated based on the amount of 120 000 tons of aluminum every year;
•the payer of the fixed price - the international Bank;
•the payer of the floating prices plant;
•payment terms - eight quarterly payments in for two years;
•fixed price - $1450 per ton;
•floating price - the average daily price of aluminum on the London stock exchange of metals (English). The London Metal Exchange, LME) during each quarter of the preceding regular payment;
•calculations are made by means of payment of the difference between the financial flows, physical delivery of the goods is not happening.
During the validity of the Commodity Swap the plant carries out deliveries of metal to its consumers at the current market price, but according to the commodity swap revenues during the following two years are fixed at the price of $1450 per ton. For example, if in the second half of the market price to fall to $1259, the income of the producer does not change. Current losses will be compensated by gains in Commodity Swap. In the opposite case, if the price in the market will be higher, wins the pot, and the plant does not receive from the additional profits. As you can see from this example, both have their benefits. The plant reduces, i.e. practically completely excludes their risks associated with falling prices, and the Bank earns money on the market situation. Of course, the Bank will have additional benefits, as the volume of cash flows, which pass through the, are large enough.
