marin bozic university of minnesota – twin cities guest lectures for cornell university - aem3040
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Dairy Risk Management. Marin Bozic University of Minnesota – Twin Cities Guest Lectures for Cornell University - AEM3040. What is a futures contract?. - PowerPoint PPT PresentationTRANSCRIPT
Marin BozicUniversity of Minnesota – Twin Cities
Guest Lectures for Cornell University - AEM3040
Dairy Risk Management
What is a futures contract?
Futures contract is a promise to do a certain deed at a specified time. If you sell corn futures contract, you have promised to deliver 5,000 bushels of corn to one of several delivery locations specified in the contract.
YOU EXCHANGE
5000 bushels of corn
Futures price at contracted time
Taking a Position
• Selling a futures contract means promising you will sell a good specified in the contract at contract maturity. That is called a short position, due to the fact that at the time you promise to sell the commodity, you do not already own it, you are short. • Buying a futures contract means promising you will
buy a good specified in the contract at contract maturity. That is called a long position.
Dairy Futures and Options
1. Class III Futures2. Class IV Futures3. Nonfat Dry Milk Futures4. Dry Whey Futures5. Butter Futures6. Cheese Futures
What is Exchanged in a Futures Contract?
Dairy futures contracts can be thought of as exchange of financial streams. For example, if you sell Class III milk futures…
YOU EXCHANGE
You pay AnnouncedClass III Milk Price
You receive Class III Milk Futures Price, as it was on the
date Futures Contract was Sold
On April 1, 2013Class III Milk Futures was
$18.82
Risk-Reward Diagram: Short Futures Position
8.509.50
10.5011.50
12.5013.50
14.5015.50
16.5017.50
18.5019.50
20.5021.50
22.5023.50
-$10.00-$8.00-$6.00-$4.00-$2.00$0.00$2.00$4.00$6.00$8.00
10/13/2008:Feb 2009 Class III Milk Futures:
$15.31
Feb '09 Class III Milk Price
Profi
t fro
m a
sho
rt fu
ture
s po
sitio
n
Class III Milk Futures
Dairy Futures and Options
Minnesota mailbox milk price was on average $1.36 higher than Class III Milk Price over 2001-2013 period.
$8.50 $13.50 $18.50 $23.50$0.00
$5.00
$10.00
$15.00
$20.00
$25.00
R² = 0.970430284693412
Class III Price
Min
neso
ta M
ailb
ox P
rice
Basis
Basis = Cash – Nearby Futures
… in grain markets: cash corn bid at local elevator minus CME futures corn price
… in milk markets: mailbox milk price minus nearby milk futures price
Hedging ExampleOctober 13, 2008Sell 1 Feb ’09 Class III milk
contract @ $15.31/cwtExpected milk check basis + $2.40 / cwtExpected net selling price in
February 2009:
$15.31 + $1.36
$16.67
futures priceexpected basis
expected price
What Happened after you hedged?
Economic downturn accelerated in autumn of 2008.
USDA Announced February 2009 Class III milk price was 9.31
Average February 2009, mailbox price for Minnesota was 11.82, or 5.89 below what was expected in early October 2008.
Hedging ExampleOctober 13, 2008 February 27, 2009Sell Feb ’09 Class III milk
contract @ $15.31/cwtAnnounced Class III milk Price
@ $9.31/cwtExpected milk check basis + $1.36 / cwt
Feb Milk Check @ $11.82/cwtRealized basis is +$2.51/cwt
Expected net selling price in February 2009:
Realized net price in February:
$15.31 + $1.36
$16.67
futures priceexpected basis
expected price
$11.82+ $6.00
$17.82
cash salefutures change(sold at $15.31, bought at $9.31)
realized price
Risk-Reward Diagram: Unhedged Production
$0.00
$5.00
$10.00
$15.00
$20.00
$25.00
$30.00
10/13/2008:Feb 2009 Class III Futures: $15.31Expected MN
Mailbox Price for 09/2009: $16.67
MN Mailbox Milk Price for Feb 2009
Announced Feb '09 Class III Price
Expe
cted
MN
Mai
lbox
Milk
Pric
e
Risk-Reward Diagram: Unhedged Production
NY Mailbox Milk Price Depends on More than Class III
August 2011 Utilization in FMMO 1
Predicting NY Mailbox Milk Price
Jan-05
Aug-05
Mar-06Oct-
06
May-07
Dec-07Jul-0
8
Feb-09
Sep-09
Apr-10
Nov-10Jun-11
Jan-12
Aug-12
Mar-13Oct-
13$0.00
$5.00
$10.00
$15.00
$20.00
$25.00
Predicted NY Mailbox
Forecasting NY Mailbox Milk Price
Advanced Class III, IV Prices
Announced Class III, IV Prices
Max (July Class III Milk Futures, July Class IV Milk Futures)
August Class III Milk Futures, August Class IV Milk Futures
August 2011 Utilization in FMMO 1
Hedging August 2011 NY Mailbox Milk PriceApril 1, 2011 September 2, 2011Sell Jul’11 Class III milk
contract @ $17.32/cwt July Class III milk contract @
$21.39/cwtExpected Mailbox Milk Price $20.56/ cwt
Expected Basis over Class III Milk: $3.24/cwt
Aug Milk Check @ $21.92/cwtRealized basis is +$0.53/cwt Realized net price in August:
$21.92- $4.07
$17.85
cash salefutures change(sold at $17.32, bought at $21.39)
realized price
Minnesota Mailbox Milk Price – Class III Milk Price
Jan-05
Aug-05
Mar-06Oct-
06
May-07
Dec-07Jul-0
8
Feb-09
Sep-09
Apr-10
Nov-10Jun-11
Jan-12
Aug-12
Mar-13Oct-
13-$2.00
-$1.00
$0.00
$1.00
$2.00
$3.00
$4.00
MN
Mai
lbox
Min
us
Anno
unce
d Cl
ass I
II M
ilk P
rice
Average: $1.42 Standard Deviation: $0.62
New York Mailbox Milk Price – Class III Milk Price
Jan-05
Aug-05
Mar-06Oct-
06
May-07
Dec-07Jul-0
8
Feb-09
Sep-09
Apr-10
Nov-10Jun-11
Jan-12
Aug-12
Mar-13Oct-
13-$2.00
-$1.00
$0.00
$1.00
$2.00
$3.00
$4.00
NY
Mai
lbox
Min
us A
nnou
nced
Cl
ass I
II M
ilk P
rice
Average: $1.40 Standard Deviation: $0.99
Hedge with a basket of Class III and Class IV contracts
Average: $1.68 Standard Deviation: $0.32
Jan-05
Sep-05
May-06
Jan-07
Sep-07
May-08
Jan-09
Sep-09
May-10
Jan-11
Sep-11
May-12
Jan-13
Sep-13
-$2.00
-$1.00
$0.00
$1.00
$2.00
$3.00
$4.00
NY
Mai
lbox
Min
us A
vera
ge o
f An
noun
ced
Clas
s III
and
Clas
s IV
Milk
Pric
es fo
r Prio
r Mon
th
Hedging August 2011 NY Mailbox Milk PriceApril 1, 2011 September 2, 2011Sell 1 Jul’11 Class III milk
contract @ $17.32/cwtSell 1 Jul’11 Class IV milk
contract @ $19.69/cwt
Announced July Class III milk @ $21.39/cwt
Announced July Class IV milk contract
@ $20.33/cwt
Expected Mailbox Milk Price $20.56/ cwt
Aug Milk Check @ $21.92/cwt
$21.92- $2.35
$19.57
cash salefutures change
realized price
Hedging February 2009 NY Mailbox Milk PriceOctober 13, 2008 February 27, 2009Sell Jan’09 Class III milk
contract @ $15.27/cwtSell Jan’09 Class IV milk
contract @ $13.00/cwt
Announced Jan Class III milk contract @ $10.78/cwt
Announced Jan Class IV milk contract
@ $9.59/cwt
Expected Feb ’09 Mailbox Milk Price
$16.16/ cwt
Feb Milk Check @ $11.72/cwt
$11.72+ $3.95
$15.29
cash salefutures change (gain on Class III: $4.49, gain on class IV: $3.41)
realized price
Hedging with Futures: Summary
By selling futures contracts, you reduce your milk price risk. Ideally, gains on the hedging account will just compensate for the decline in mailbox milk price.
Basis risk is the risk that losses on the hedging account will not be compensated for by a proportional increase in cash prices. Basis risk can be reduced by a proper choice of futures contracts used to hedge, but can never be fully eliminated.
If basis risk is much smaller than price risk, then hedging makes sense, even if it is “noisy” from time to time.