This lesson introduces the management of commodity price risk, a consideration for companies exposed to raw material prices.
6.1. Defining Commodity Risk
Commodity risk is the risk of loss from adverse movements in the prices of raw materials and other commodities. This can have a significant impact on a company’s input costs and profitability .
6.2. Hedging Techniques
Managing commodity risk involves similar techniques to FX and interest rate risk:
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Forward Contracts:Â Locking in prices for future purchases or sales.
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Futures and Options: Using exchange-traded instruments to hedge commodity exposure .
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Commodity Swaps:Â Exchanging a fixed commodity price for a floating one.
6.3. Strategies for Commodity Risk
The choice of hedging strategy depends on the nature of the exposure, the company’s risk appetite, and the availability of suitable instruments . Some companies may also use physical hedging, such as securing supply contracts with fixed prices .