Purchase basis is the difference between revenue from a futures contract and the price of a cash product. Investors use it to determine the best buying approach, based on market conditions and projections. Cash products are physical items, while futures contracts are agreements to buy options at a later date. The investor must decide whether to pay a certain price today or enter into an alliance to pay a different price later, based on anticipated performance. The purchase basis can also help investors decide whether to secure an asset through a futures contract.
In general, a purchase basis is understood as the calculation of the difference between the revenue that can be generated with a futures contract and the actual price associated with a cash product. Determining the buying basis can help an investor determine what type of buying approach would be the best move, given the current market circumstances, as well as projections of how the market will behave when the future is due.
To understand how to properly ascertain purchase basis, you need to understand what is meant by cash commodities and futures contracts. In essence, a cash product is the actual physical item offered for sale. Sometimes referred to as actuals, this type of physical commodity can take a variety of forms. Commodities such as corn or soybeans are examples of cash or physical commodities. Precious metals such as gold and silver also qualify as this type of commodity. Even items like treasury bills meet the basic requirements to be considered a physical commodity.
The second type of buy or sell involved in calculating a buying basis is the futures contract. This type of contract basically creates an agreement for one investor to buy an option that is being sold by another investor. The difference is that with a forward contract, payment is deferred to another specified time, rather than immediately. Second, the actual cost for the merchandise may be by an amount other than the current market value. The idea behind a futures contract is to be able to acquire the asset at a price that may or may not be competitive today, but is expected to be very profitable on the date the payment is due.
In determining the buying basis for an investment opportunity, the investor’s job is to decide whether to make a greater profit by paying a certain price today or by entering into an alliance to pay a different price later. Much of the decision rests with the anticipated performance of the business. If you anticipate that market conditions will cause the value of the asset to increase significantly by the maturity date, you may want to pay slightly more than the current market price. On the other hand, if the future performance of the business is expected to be somewhat modest, there may be no real reason to pay more than the current market rate for the investment.
Projecting the best course of action using the buy basis can also be useful for the investor who expects to have access to more assets at a later date. In such a case, the investor may determine that the purchase basis indicates that securing an asset by means of a futures contract might be wiser. This is especially true if the investor prefers to use current assets for other purposes and rely on other investments to pay off before the termination date arrives.
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