Junior and Senior level Ag Bus.

Colorado Agribusiness Curriculum

Section: / Advanced Agribusiness
Unit: / Marketing
Lesson Title: / Forward Contracts
Colorado Ag Education Standards and Competencies / AGB11/12.04 - The student will understand the influences of agricultural economy and its influences on the overall economy.
AGB11/12.04.14 - Understand forward contracts.
Colorado Model Content Standard(s): / English Standard 1: Students read and understand a variety of materials.
English Standard 4: Students apply thinking skills to their reading, writing, speaking, listening, and viewing
English Standard 5: Students read to locate, select, and make use of relevant information from a variety of media, reference, and technological sources.
Student Learning Objectives: /
  • Student will be able to (SWBAT) explain the two types of contracts
  • SWBAT list and explain the parts of a contract
  • SWBAT understand and explain a forward contract

Time: / 1-50 minute period
Resource(s): / Marketing Grain & Livestock, 2nd Edition, by Gary F. Stasko, IowaStateUniversity Press, ISBN 0-8138-2957-7


Strategies for Great Teaching, by Mark Reardon and Seth Derner, ISBN 1-56976-178-7
Farm and Ranch Business Management, by Deere Company, ISBN 0-86691-135-9

Instructions, Tools, Equipment, and Supplies: / Lesson Plan, Computer, LCD Projector or copies of PowerPoint, Three boxes, one that is empty, one with fifty cents and one with a cookie in it. (Contents in box may vary) Enough cookies for the whole class plus one dozen. Access to computers with internet
Interest Approach: / Deal or No Deal
Select a student or group of students to play deal or no deal
This is a game where the students will have three boxes in front of them and they will get to chose one. They are not allowed to look in the box to see what is inside until you say so. Explain the possible contents of the boxes and that they will have a chance to trade their box with you. Once they have chosen a box ask them to make a deal with you or otherwise enter into a contract with you that they can have what’s in the box or 1 dozen cookies. Once they have chosen to either trade with you or keep the box explain to them that they have entered into a binding agreement just like when you sign a contract. Now open the box and see if they made a good deal or bad deal. Explain that sometimes in life you make good deals when signing a contract and not such good deals. Now ask students what made that a contract?
Objective 1: / What is a contract
  • A legally enforceable arrangement or agreement between two or more parties
Two Types of Contracts
  • Expressed – parties state the terms of the contract orally or in writing
  • Inferred – the actions or conduct of the parties indicate and intention to contract

Objective 2: / Four essential elements of an enforceable contract
  • Two or more legal parties
  • Must be mentally competent
  • Must be legal age under the state law
  • Offer and Acceptance
  • Evidence all parties intend to be bound by agreement
  • Usually an offer by one party and accepted by the other party
  • Sufficient Consideration
  • A promise
  • May be money, goods, or a promise for a promise
  • Must be lawful – not offend public policy or morals

Objective 3: / Forward Contract
  • A forward contract is an agreement between two parties to buy or sell an asset (which can be of any kind) at a pre-agreed future point in time.
  • Therefore, the trade date and delivery date are separated.
  • One party agrees to sell, the other to buy, for a forward price agreed in advance. In a forward transaction, no actual cash changes hands. If the transaction is collaterised, exchange of margin will take place according to a pre-agreed rule or schedule. Otherwise no asset of any kind actually changes hands, until the maturity of the contract.
  • The forward price is given by:
  • where
  • F is the forward price to be paid at time T
  • ex is the exponential function (used for calculating compounding interests)
  • r is the risk-free interest rate
  • q is the cost-of-carry
  • S0 is the spot price of the asset (i.e. what it would sell for at time 0)
  • Di is a dividend which is guaranteed to be paid at time ti where 0 < tiT.
  • The forward price of such a contract is commonly contrasted with the spot price, which is the price at which the asset changes hands (on the spot date, usually two business days). The difference between the spot and the forward price is the forward premium or forward discount.

Example of how the payoff of a forward contract works

Suppose that Bob wants to buy a house in one year's time. At the same time, suppose that Andy currently owns a house that he wishes to sell in one year's time. Both parties could enter into a forward contract with each other. Suppose that they both agree on the sale price in one year's time of $104,000 (more below on why the sale price should be this amount). Andy and Bob have entered into a forward contract. Bob, because he is buying the underlying, is said to have entered a long forward contract. Conversely, Andy will have the short forward contract.
At the end of one year, suppose that the current market valuation of Andy's house is $110,000. Then, because Andy is obliged to sell to Bob for only $104,000, Bob will make a profit of $6,000. To see why this is so, one needs only to recognize that Bob can buy from Andy for $104,000 and immediately sell to the market for $110,000. Bob has made the difference in profit. In contrast, Andy has made a loss of $6,000. To see why this is so, one needs only recognize that Andy could have sold to the open market $110,000 rather than Bob for $104,000. Unfortunately for Andy, he is legally obliged to sell to Bob at the lower price.
Review/Summary: / Using the example above Identify the type of contract and the essential parts of a contract.
This is an expressed contract because the two parties agreed on a price and time with words not actions
Two or more legal parties: Andy is one party and Bob is the other
Offer and Acceptance: The agree on the one year sell price of 104,000
Sufficient Consideration: One years time
Must be lawful: Nothing illegal is happening.
This is a forward contract because aforward contract is an agreement between two parties to buy or sell an asset (which can be of any kind) at a pre-agreed future point in time. This is a contract to buy and sell a house made between Andy and Bob for a prearranged price of 104,000 in one year.
Application--Extended Classroom Activity: / Have each student create a poster that displays all the aspects of a contract and a futures contract as well as how to find the specifications and give examples.
Application--FFA Activity: / Ag Business Management
Commodity Marketing Challenge
Application--SAE Activity: / Look up specifications for a commodity related to their SAE.
Develop a possible contract that would be for their or a classmates SAE to make it a fair and equitable contract. It would be great for a producer to find a consumer in class and try to develop a contract for a commodity.
Evaluation: /

Give students resource web sites and have them look up the specifications for a forward contract on a commodity of their choice then have them create a scenario where they could use a forward contract.

Evaluation Answer Key: /

All students’ answers will be different depending on the commodity they chose.

Other: / [ Click here and enter information. ]

Unit 5, Lesson 7: Forward Contracts1