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The Basics, Importance, & Need of Risk Management

This article discusses the basics, importance, and need for risk management in agricultural lending. It covers various types of risks, such as production, price, financial, institutional, and human risks. The article also suggests strategies for managing agricultural risks, including enterprise diversification, financial leverage, vertical integration, contracting, hedging, and crop insurance. It emphasizes the negative impact of fear, greed, and ego in marketing decisions and provides tips for building a marketing plan. The article concludes by highlighting the role of cash flow management and outlining pre-harvest and contracting strategies.

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The Basics, Importance, & Need of Risk Management

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  1. The Basics, Importance, & Need of Risk Management Ag Lending Meeting South Bend, Nebraska Sept. 28, 2011 Chad Hart Assistant Professor/Grain Markets Specialist chart@iastate.edu 515-294-9911

  2. Corn Prices vs. Costs

  3. Production risk Price or market risk Financial risk Institutional risk Human risk Agricultural Risks Source: USDA-ERS, Dismukes, Aug. 2009

  4. Enterprise diversification Financial leverage Vertical integration Contracting Hedging Liquidity Crop insurance Off-farm income and/or investment Ag. Risk Management Source: USDA-ERS, Dismukes, Aug. 2009

  5. Fear, Greed, and Ego Fear of making a bad decision -- Watching prices slip away as you wait Greed of expecting even higher prices -- Not taking advantage of good price opportunities Ego of wanting to claim you caught the market high -- “Lake Wobegon” marketing

  6. Ego Greed Fear

  7. Marketing Plan To avoid fear, greed, and ego dominating your marketing, have a plan and stick to it. A marketing plan outlines your market strategy and your marketing objectives. It should examine marketing opportunities before and after harvest.

  8. Building a Marketing Plan 5 basic steps: • Estimate number of bushels/animals to sell • Calculate breakeven price • Project price and production scenarios • Compare pricing tools and analyze market opportunities • Develop a pricing plan

  9. Outlining Cash Flow Needs http://www.extension.iastate.edu/agdm/crops/pdf/c3-15.pdf

  10. Outlining Cash Flow Needs http://www.extension.iastate.edu/agdm/crops/pdf/c3-15.pdf

  11. Iowa Averages, 2000-2009 http://www.extension.iastate.edu/agdm/wholefarm/pdf/c3-55.pdf

  12. Seasonal Pattern

  13. Pre-Harvest Strategies 56% 52% 52% 52% 72% 68% 68% 68% 72% 68% Source: Farm Futures magazine

  14. Contracting • Basic Hedge-to-Arrive • Basis • Deferred Price • Minimum Price • New Generation • Automated Pricing • Managed Hedging • Combination

  15. Market tools to help manage (share) price risks Mechanisms to establish commodity trades among participants at a future time Available from commodity exchanges / futures markets Futures and Options

  16. Buyer Pays premium, has limited risk and unlimited potential Seller Receives premium, has limited potential and unlimited risk Buying puts Establish minimum prices Buying calls Establish maximum prices Summary on Options

  17. Average Price Captured

  18. Lowest Average

  19. Highest Average

  20. Longer History

  21. Decision Chart Futures Increase • Basis Contract • Sell Cash and Buy Futures • Call Options • Minimum Price Contract, Fixed Basis • Store & Wait to Price • Delayed Price Contract • Minimum Price Contract, Variable Basis Basis Weakens Basis Strengthens Expected Change • Hedge • Hedge to Arrive • Put Options • Cash Sale • Forward Contract Futures Decrease

  22. Factors Leading to Higher Commodity Prices Source: USDA-ERS, Trostle, July 2008

  23. Government Programs Direct payments – Crop-specific income support Counter-cyclical payments – Crop-specific price support Marketing loans – Crop-specific price support ACRE – Crop-specific revenue support SURE – Whole-farm revenue support

  24. Federal Crop Insurance

  25. Causes of Loss for Iowa Corn, 1948-2010

  26. Causes of Loss for Iowa Soy, 1955-2010

  27. Acres Insured in 2011 Corn and Soybeans--Iowa

  28. CornInsurance Prices

  29. Current Subsidy Rates

  30. Premium Differences 2011 Story County, Iowa Corn 180 bushel APH 2 100-acre optional units Revenue Protection

  31. Coverage Level Choice

  32. Iowa Averages, 2000-2009 http://www.extension.iastate.edu/agdm/wholefarm/pdf/c3-55.pdf

  33. Thank you for your time!Any questions?My web site:http://www.econ.iastate.edu/~chart/Iowa Farm Outlook:http://www.econ.iastate.edu/ifo/Ag Decision Maker:http://www.extension.iastate.edu/agdm/

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