An analysis of the funding of margin requirements for a grain hedging company

Abstract

Trading in agricultural derivatives in South Africa started since 1995 when white maize could be traded on the South African Futures Exchange. Today trading in agricultural products are common practice amongst grain producers and processors. This enables grain producers and processors to hedge themselves against price risk. The word “hedge” means to protect and in the volatile agricultural markets that were illustrated, it is of utmost importance for these market participants to protect themselves against these price risks. Grain hedging companies are companies that assist these market participants in protecting themselves against price risk. For these companies to be able to hedge grain for grain producers and processors, they must undergo major risks in these volatile markets. It was statistically illustrated that variables like supply and demand, exchange rates, international grain prices and price parity have a direct impact on the price of white maize in South Africa. These volatile white maize prices as a result have an impact on the margin requirements to fund the hedging transactions for market participants. This stresses the demand for trading strategies to mitigate these risks associated with the funding of margin requirements. This study used a trading strategy to assist the hedging company to manage the capital requirements to fund their margins on the South African Futures Exchange. The trading strategy that was used was the Slow Stochastic Indicator, which served as a framework to determine what the margin requirements would be when this specific trading strategy was used. The finding of the research is that by using this trading strategy when hedging grain for grain producers and processors, the margin requirement may depending on the situation decrease dramatically. Thus, decreasing the amount of capital required to fund these margins.