Cash Contract

What Is a Cash Contract?

A cash contract is a financial agreement where one party consents to purchase a predefined quantity of a commodity on a predetermined date. Not at all like futures contracts in which the purchaser frequently finishes off their contract for cash prior to the delivery date, the buyer in a cash contract generally means to take physical delivery of the commodity.

Cash contracts are common among industrial customers that depend on commodities for their production processes. On the other hand, futures contracts are many times utilized by financial examiners or traders who wish to hedge risks or estimate on price developments.

How a Cash Contract Works

Cash contracts are consistently placed into through the spot markets of different commodities. Large manufacturers routinely depend on these markets to purchase imperative commodities, like raw materials for their plants, fuel for their vehicles, and power to power their facilities and machines. These manufacturers are not hypothesizing on the price of the commodities they need, which should be possible in the futures market. All things considered, they are physically purchasing the raw materials they need for their daily operations.

As well as purchasing these commodities straightforwardly through spot markets, another way for companies to go into cash contracts is through the over-the-counter (OTC) market. In OTC transactions, the buyer will go into a cash contract straightforwardly with a specific counterparty, rather than depending on a third-party commodities exchange or clearinghouse. The advantage of OTC transactions is that they can be exceptionally redone, though exchange-put together transactions depend with respect to standardized contracts. Their primary drawback, notwithstanding, is that they can involve greater counterparty risk.

In practice, a purchaser could depend on a combination of these methods while purchasing commodities. For instance, a company could utilize cash contracts in the spot market to satisfy a large portion of their short-term supply needs, particularly when the commodities included don't need customization. At the point when non-standard delivery times, commodity types, or quantity types are required, the buyer can depend on the OTC market. What's more, finally, while taking part in risk hedging, speculation, or just planning farther in advance, buyers can depend on commodity futures.

Real World Example of a Cash Contract

To outline, consider the case of a hypothetical coffee products manufacturer called ABC Coffee. To create its product line, ABC must guarantee that it has a consistent supply of coffee beans. To accomplish this goal, ABC purchases its commodities utilizing three fundamental methods: cash contracts, futures contract, and OTC purchases.

ABC depends on cash contracts to supply a large portion of its coffee beans, paying in cash for determined amounts of beans and taking delivery of them inside a couple of days of the purchase. While making these purchases, ABC acknowledges the most recent spot price of the beans.

In times when ABC needs to plan farther into the future, it can utilize coffee bean futures contracts to supply lock in a more extended term. This method of utilizing futures contracts is particularly alluring when ABC is worried that the price of coffee beans could rise during the determined period, in light of the fact that the futures permit ABC to lock in a known price today for a long time supply of beans.

Finally, ABC can utilize OTC contracts when it needs to source coffee beans or other commodities that fall outside of the standardized amounts, delivery times, or commodity types offered by the spot and futures markets.

Features

• Industrial customers use cash contracts, especially to meet their short-term supply needs.
• They are sometimes utilized in combination with futures contracts and over-the-counter (OTC) transactions.
• Cash contracts are by buyers who wish to purchase and take physical delivery of commodities.