A forward contract eliminates what kind of risk for the farmer?

A forward contract eliminates what kind of risk for the farmer?

• A. Price risk
• B. Weather risk
• C. Credit risk
• D. Currency risk

Answer: (A)

A forward contract locks in the price at which a farmer will sell a crop on a future date. By setting that price now, the farmer eliminates exposure to changes in market prices—their revenue is known regardless of how prices move later. This is why price risk is eliminated. The contract doesn't fix yields, so weather risk remains a concern because poor growing conditions can still affect how much is produced. Currency risk would only be a factor if the contract is in a different currency. And while the contract creates a binding obligation, it doesn't remove counterparty or credit risk if the other party defaults. So the risk eliminated is price risk.

A forward contract locks in the price at which a farmer will sell a crop on a future date. By setting that price now, the farmer eliminates exposure to changes in market prices—their revenue is known regardless of how prices move later. This is why price risk is eliminated. The contract doesn't fix yields, so weather risk remains a concern because poor growing conditions can still affect how much is produced. Currency risk would only be a factor if the contract is in a different currency. And while the contract creates a binding obligation, it doesn't remove counterparty or credit risk if the other party defaults. So the risk eliminated is price risk.