First, the key terms.

Margin
Funds required under a contract or clearing arrangement to support exposure.
Basis risk
Risk that the hedge reference and actual exposure do not move together as intended.

The idea, explained

Futures positions are typically subject to margin and settlement rules, so a hedge can create cash demands even when it reduces overall economic exposure. Basis risk arises when the hedge and actual exposure do not move together perfectly. Contract size, expiry, settlement method and hedge ratio all matter. A derivative’s low initial cash requirement is not its maximum possible loss, and rolling a hedge introduces additional decisions.

STEP 1

Identify the exposure before the instrument

A bakery may worry about future ingredient costs. A related futures contract can offset some price movement, but grade, location, quantity and timing may differ. Choose the hedge ratio based on that relationship.

STEP 2

Follow interim obligations

A futures position can require additional margin before the operating benefit of the hedge is realized. Economic offset at a later date does not guarantee enough cash today. Understand settlement and expiry terms.

Follow a worked example.

A fictional bakery expects to buy wheat later and uses a related futures contract to reduce price uncertainty. The bakery buys a particular local grade, so local cash prices may still diverge from the futures reference.

Walk it through, one step at a time

  1. A bakery expects a later wheat purchase and takes a hedge intended to benefit from rising wheat prices.
  2. A temporary move against the futures position creates a margin call even though a later cash purchase may become cheaper.
  3. The bakery needs liquidity to maintain the hedge, and local wheat prices may still diverge from the contract reference.

Where people get stuck

A hedge can reduce one risk while adding liquidity, counterparty or mismatch risks.

Now try it yourself.

Pause before opening each answer. Explain your reasoning in your own words.

1. Check the core idea

Why might a profitable hedge still create a funding problem along the way?

Reveal the answer & reasoning

Interim adverse price moves may require margin before the offsetting benefit in the underlying business is realized.

2. Apply what you learned

Does a hedge remove the need for cash planning?

Reveal the answer & reasoning

No. Margin, settlement timing and imperfect matching can create cash demands even when the hedge reduces a specified economic risk.