Ward
n informal survey of industry participants during the summer of 1987 found that A the delivery specifications of the live cattle futures contract continue to represent an area of concern. Industry participants identified the following real or perceived delivery problems with the live cattle contract: (1) grading inaccuracies occur at some delivery locations and grading is thought to be more lenient at some delivery points (resulting in transportation of cattle to more lenient grading points); (2) the contract has historically been a dumping ground for lower quality cattle; (3) certain delivery points which are located outside of the primary cattle feeding areas are thought to impact futures prices adversely and increase the uncertainty faced by long hedgers regarding delivery location; and (4) current contract specifications which do not allow certain economically important breeds (e.g., Brahma) to be delivered and which limit deliverable loads to 40,000 pounds are outdated.
Cash settlement provides an alternative to physical delivery and is currently used to settle a number of futures contracts, e.g., Eurodollars, stock indices, and feeder cattle. Cash settlement eliminated the delivery problems associated with Chicago Mercantile Exchange (CME) feeder cattle futures and apparently made the basis less variable, increasing hedging effectiveness [see l.
The apparent success of cash settlement for feeder cattle and the above concerns regarding the physical delivery of live cattle cause one to wonder if cash settlement would improve the live cattle futures contract. The purpose of this paper is to examine issues relevant to cash settlement of the CME live cattle futures contract.