This article contains some outdated information. Please refer to the article “What Is the Coffee Derivatives Market?” for a more detailed understanding of the coffee futures market and forward coffee contracts.
A forward contract is an agreement between a buyer and a seller for a specific asset (such as securities, oil, or any other commodity) made at the present time, but the execution will take place in the future.
The commodity in question can be anything—from agricultural products and currencies to securities.
Under this contract, only two parties participate, and the price is mutually agreed upon based on their own estimates.
At the time of delivery, the spot market price of the commodity may have changed, rising or falling compared to the price specified in the contract. In such cases, one of the two parties will incur a loss for having committed to a lower (seller) or higher (buyer) price than the market price.
By entering into a forward contract, both parties limit their potential risk as well as their potential profit.
Because only two parties are involved, each relies solely on the other to fulfill the contract. When spot market prices fluctuate, the risk of default increases if one of the parties fails to honor the agreement. In addition, because the agreed price is personal and subjective, it may not be entirely accurate.
Example
Coffee prices in Vietnam are often unstable, fluctuating with world coffee prices and weather conditions.
In years with good weather and falling global coffee prices, domestic coffee prices also drop, causing losses for coffee farmers. Conversely, in years with poor weather and rising global coffee prices, domestic coffee prices climb, making it difficult for coffee exporters to purchase from farmers.
To avoid such instability, a coffee exporter—such as DakLak Import-Export Joint Stock Company (CP XNK DakLak)—can negotiate and sign a forward coffee purchase contract with Thinh Coi, a farmer.
For example, at the beginning of the season, CP XNK DakLak signs a six-month forward contract to buy 20 tons of coffee from Thinh Coi at 28 million VND per ton. In this agreement, Thinh Coi is the seller and CP XNK DakLak is the buyer.
After six months, Thinh Coi must sell 20 tons of coffee to CP XNK DakLak at the pre-agreed price of 28 million VND per ton, and CP XNK DakLak is obligated to buy the coffee at that price, regardless of how the market price of coffee changes during that period.
With the predetermined and fixed price, both Thinh Coi and CP XNK DakLak gain peace of mind, free from worries about fluctuations in coffee market prices.