Taketake agreements can also provide an advantage to buyers and serve as a means of securing goods at a specified price. This means that prices for the buyer will be set before the start of production. This can be used as a hedge against future price changes, especially when a product becomes popular or a resource becomes scarcer, so that demand outstrips supply. It also guarantees that the requested assets will be delivered: the execution of the order is considered an obligation of the seller in accordance with the terms of the taketake contract. Taketake agreements also contain standard clauses that contain remedies – including penalties – that each party has in the event of a violation of one or more clauses. Taketake agreements are often used in the development of natural resources, where the cost of capital for resource extraction is high and the company wants to be guaranteed that part of its product will be sold. Taketake agreements are generally used to help the distributor acquire financing for future construction, expansion or new equipment projects, promising future revenues and demonstrating existing demand for goods. Most agreements contain force majeure clauses. These clauses allow the buyer or seller to terminate the contract if certain events occur outside the control of one of the parties and when one of the other parties encounters unnecessary difficulties. Reducing risk therefore always means reducing the potential benefits. Therefore, hedging is largely a technique designed to reduce potential losses (and not maximize potential benefits). If the investment you guarantee earns money, you usually also reduce your potential profit. However, if the investment loses money and your coverage has been successful, you have reduced your loss.
The best way to understand coverage is to consider it as a form of insurance. When people decide to cover themselves, they insure themselves against the consequences of a negative event on their finances. This does not prevent all negative events from occurring. However, if a negative event occurs and you are properly protected, the impact of the event will be reduced. Another example of conventional coverage is a company that depends on a particular product. Suppose Corys Tequila Corporation is concerned about the volatility of the price of agave (the plant used to make tequila). The company would be in great difficulty if the price of the agave were to soar because it would severely affect its profits. While it may seem that the term “protection” refers to something that is done by your garden-obsessed neighbor, when it comes to investing protection, it is a useful practice that any investor should know about.