Taking Charge of Managing
Risk on Your Farm
March 12, 2002
Moonraker Restaurant
Marshall
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Let’s start by testing how you think
about risk:
Which would you prefer?
A. 80% chance you will win $4,000
20% chance you get $0
B. Win $3,200
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How about a downside choice:
Which would you prefer?
C. Lose $3,200
D. 80% chance you will lose $4,000
20% chance you lose nothing.
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Summary:
A. 80% chance you will win $4,000; 20% Zero
B. Win $3,200
C. Lose $3,200
D. 80% chance you will lose $4,000; 20% Zero
Most people answer B and D
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• In the 1st “lottery,” the average was the same for
both choices: + $3,200.
80% x $4,000 + 20% x $0
vs $3,200 for sure
• In the 2nd “lottery,” the average was the same
for both choices: (- $3,200).
80% x (- $4,000) + 20% x $0
vs (- $3,200) for sure
• Most respondents were willing to give up upside
potential. But, they kept downside risk.
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We tend to be inconsistent in our risk
perceptions and choices:
• On one hand, many overreact to eyecatching, low probability events.
• On the other hand, we tend to ignore
unlikely, low probability price and yield
events when making plans. It won’t
happen to me!
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Research Suggests:
• We tend to spend too much on more
routine “hits” that, while unpleasant,
can be coped with ...
• But we often don’t pay enough
enough attention to protecting against
big hit, low probability events.
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Summary:
• How we “frame” information and choices tends
to keep us from making pricing and insurance
choices that are as good as they can be.
• The consequences of these biases can be
significant!
• Biases are normal. One focus of this workshop
is designed to help you keep them from getting
in the way of making good decisions.
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Decision Making Environment
• Do you have written goals for your farming
operation?
• Are you meeting your Goals?
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Basic Goals Include...
• Generating sufficient net income to
support a comfortable “family income
draw” from the farm business
• Ensure the financial
survival and profitability
of the farm business
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And, ...
• Have high level of satisfaction from the
farm business
• See growth in farm business net worth
• Maintain financial ability to take advantage
of business opportunities
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But, farms must contend with ...
• Ups and downs in the economic
climate
• Lousy weather … that reduces yield,
quality, or the ability to get in the field
• Changes in the USDA safety net
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• Let’s review some recent history
• Are there lessons that we can
draw?
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Corn futures: the long view
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Reality Check I
• Did the $5.00 spike in corn prices cloud
your neighbors judgement in pricing
1998 corn? 1999? 2000? 2001?
• Did your neighbor “bet” on a drought in
Iowa and Illinois in 1998? On drought
in the western corn belt in 1999? On
the “Drought of 2000”?
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What did the market say in
March ‘98?
• 50-50 bet was CBOT harvest futures
contract on corn at $2.70 / bu
• One chance in 3 of $2.50 or less
• One chance in 12 of $2.10 or less
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On the up side:
• One chance in 3 of CBOT corn futures
at harvest exceeding $2.90 /bu
• One chance in 5 of corn exceeding
$3.10
• One chance in 12 of corn over $3.50
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100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
Dec '98 Futures @ hvst
3.70
3.50
3.30
3.10
2.90
2.70
2.50
2.30
2.10
1.90
0%
1.70
Chances out of 100 price will be less
than…
Summary of the market’s estimate of price risk
exposure in early March ‘98
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What did the market do 1998?
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Were There Lessons From 1999?
What About 2000 and 2001?
2002 ?
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Reality check II
• Are yields more or less variable than
annual average prices?
• Do farmers responses match what
their records show?
• For most farms, yield risk exposure is
real
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Chances of alternative corn yields: a review
of the last 50 years for a Gratiot Co. Farm
20%
18%
Chances in 100
16%
14%
12%
10%
8%
6%
4%
2%
0%
10
28
46
64
82
100
118
Yield/planted acre
136
154
172
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Reality check III
• On the average, over the last 27 years,
there has been a 5¢ to 15¢ premium
for pricing in the late spring-early
summer weather market
• But, I don’t pre-harvest price because
of yield risk, contract delivery
exposure
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Check?
• Is the yield risk exposure large
enough to keep you from selective
pre-harvest pricing?
• Are there other ways to get around
yield risk exposure concerns?
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Changes...
• USDA no longer attempts to balance
supply and demand with Acreage
Reduction Programs
• Grain stock holding decisions are now
in the private sector
• But, LDP’s may effect farmer’s timing
of sales.
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How do prices respond to ending
stocks?
3.4
3.3
95
3.2
3.1
Dec Futures $/bu
3
2.9
2.8
97
93
2.7
96
2.6
91
2.5
2.4
90
2.3
94
2.2
92
2.1
2
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
30.0%
Stocks-to-Use Ratio
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Taking Charge of
Managing Your Risks:
Goal = Increase Profitability and
Ensure Financial Survival
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Today’s workshop will...
• Help you identify and clarify how to
manage your financial risk exposure
• Develop options that could improve
your profitability and reduce the risk
exposure in your operation
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Today’s workshop will...
• Help you structure your information on:
– Your capacity to bear risk
– Revenues, required to cover:
• Cash flow requirements
• Maintain current level of equity
• Review the risk control tools that are available
• Use these “tools” in a “hand’s-on” case study –
so you can use them on your farm
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END
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