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Current time:0:00Total duration:3:11

Video transcript

every year this Apple farmer produces 1 million pounds of apples 1 million pounds but he's got a problem every year the apple price jumps around a bunch sometimes it sells after the harvest for over 30 cents and this guy makes a ton of money per pound and then sometimes it drops down to 10 cents per pound and this guy can't even cover his cost and on the other side of the equation you have this pie chain right over here so they they specialize in making apple pies and when the price of Apple's goes super-high these guys can't cover their costs they start running a loss but when the price goes really low they have this kind of bonanza but neither party here likes this scenario they don't like the unpredictability of one year having a feast and then one year having a famine so what they can do is let's say we have the harvest coming up the pie farmer is kind of afraid well what if the price of pies goes back down to 10 cents per pound then he's going to go broke the pie chain is afraid what if the pie price of pies goes up to 30 cents a pound then these guys are going to go broke so what they can do is agree ahead of time regardless of what the actual market price of pies ends up being after the harvest they could agree to transact at a specified price so they could set up a little contract right here so they could set up a contract where the chain the chain agrees agrees to buy to buy 1 million pounds at a specified date let's just say after the harvest at the harvest for 20 cents a pound 20 cents a pound this works out well for the chain because they can insure regardless of what the market price ends up being they can ensure that they will pay 20 cents a pound which is a good price where they can make a decent profit and at least they have the predictability and they can plan on things and it works out for the farmer because he knows that at 20 cents a pound he can cover his costs and pay his rent and pay his employees and feed his family and it also takes out the unpredictability the volatility for him for him for him as well so what we have set up right here is actually called a forward contract this is a forward contract and what it is as you can see is an agreement and it's an obligation for both parties to transact in the future at a specified price so at the time of this harvest they would specify when they write this contract they would specify this date I don't know what it might be November 15th and at November 15th this farmer is obligated to deliver a million pounds of apples and then this pie chain is obligated to produce the money to pay 20 cents a pound or essentially produce $200,000 and that way they both are essentially able to to avoid the volatility and make sure that they can survive