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«Price, Yield and Enterprise Revenue Risk Management Analysis Using Combo Insurance Plans, Futures and/or Options Markets Authors: Duane Griffith, ...»

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Price, Yield and Enterprise Revenue Risk Management Analysis Using

Combo Insurance Plans, Futures and/or Options Markets

Authors:

Duane Griffith, Montana State University, Extension Farm Management Specialist and

Matthew Diersen, South Dakota State University, Extension Risk and Business Management

Specialist

Introduction:

This user’s manual provides a brief overview of software that analyzes possible combinations of

risk management strategies to protect price, yield or enterprise revenue with the new Combo Insurance Policy Plans, the Futures and/or the Options markets.

The first portion of this manual is a tutorial using screen captures from the software with a “text book” hedge example, i. e. after the fact, everything works out exactly as you (and the markets) expected at the time the insurance policy and/or Futures/Options were purchased.

This software allows comparison of multiple levels of yield, price and revenue protection offered by futures and options contracts in combination with the new Combo Policy Plans offered by RMA. The second portion of this manual provides examples of specific risk management strategies and how the available tools can be combined to implement effective strategies for “typical” situations to the worst case scenario.

The Combo Policy consolidated several previous insurance policies into one policy. The Combo Policy uses the Futures and Options markets when establishing the RMA Projected Harvest Price and Harvest Price. Familiarity with all three of these risk protection tools will help evaluate possible risk protection strategies offered by any combination of these alternatives.

For comparative analysis, this software includes adjustments for the differences in the way futures, options and Combo Policy “plans” are implemented and the transactions cost incurred for each product so the bottom line provides an accurate comparison.

To complete this analysis, use the tabs across the top of the screen, Figure 1, going from left to right, and enter requested information on each tab in the software. You are asked to enter the initial values for all the variables used in this software on the General Inputs tab. After entering these values, they also appear, and can be changed, on some of the other tabs. Once a value is entered for any variable, it does not have to be reentered in other locations within the software, if that value does not change. Changing a value that appears on any of the tabs changes that value everywhere it appears. This allows you to change numbers in “What If” analysis on the Summary Results tab to see how yield/price/revenue protection levels vary by alternative and how different factors affect yield/price/revenue protection strategies.

Each individual page (tab) may have several data entry steps. Enter all necessary information for the comparison you wish to make. The Summary Results tab allows changing key values previously entered to see how a value change impacts the relative yield/price/revenue protection levels for futures, options and Combo Policy Plans or for various combinations of these alternatives.

The Cost of Production tab allows estimations for the cost of production for up to two different crop enterprises. The cost of production per bushel calculation can be then be entered on the General Inputs tab. The software uses this to estimate net returns per acre under different strategies. Using the cost of production estimation part of the software is optional. You can enter your own estimated cost of production if available, or leave it blank.

Getting Started:

This software runs inside the Internet Explorer web browser. Other possible browsers may also run this software, but they have not been tested with this software. The software will run from the web, http://www.montana.edu/softwaredownloads/financialmgtdownloads.html where it is located, or it can be downloaded to your computer and run for your local computer, without being connected to the web. Follow the instructions at the link above to download and run this software.

Figure 1 is a screen capture of the Introduction page (tab) of this software. This tab includes text with a brief explanation of the software and the types of “components” you can interact with while using this software.

These components include Scrolling text windows, Toggle Buttons, URL Link Buttons, Check Boxes, and data input cells highlighted with a blue background. Text windows that scroll use the typical scroll bar to move up or down to view text. Toggle Buttons are activated by clicking on the button with your mouse pointer, or moving your mouse pointer over the top of the button without clicking, a mouse over. A Toggle Button works as an On/Off button. The first click, or mouse over will, display a message or other information and the second click, or moving the mouse pointer off the button, will hide the information displayed. A Toggle Button may or may not be labeled as a mouse over activation, depending on the screen space that was available in the software to insert the button. Some Buttons look similar to Toggle buttons but activate a link to resources located on the web that may be useful while operating this software. These buttons are clearly labeled as Get….From the Web, or something similar.





When you click on one of these buttons, a new browser window is opened and the link takes you to resources located on the web. In order for these web linked buttons to work, your computer must be connected to the web via cable modem, high speed wireless connection, LAN, or if you have dial up internet service, that service must be connected.

Cells highlighted with a blue background can be changed in two ways. Move the mouse pointer over the top of a cell with a blue background, then click and hold the left mouse button and drag the mouse pointer up to increase the cell value, or down to decrease the cell value. Each data input cell has built in limits for high and low values and the size in which the cell value is incremented. Some cells can have both negative and positive values. If you computer is an older model with a slow processor speed, it may be relatively slow to change the values while dragging the mouse pointer up or down. You can also double click on a cell with a blue background and type in a new number, but you must delete the existing number first.

Check Boxes are also used to control what is being displayed on the screen. Check boxes are used in several locations to select the type of information displayed, or the calculations being performed. Check boxes are always used to toggle (display/hide) information as needed throughout the software. The information displayed or hidden can be help messages, required input data or calculated results.

Familiarize Yourself With This Software:

This software is intended to compare and contrast different marketing and risk protection strategies for farmers. Available strategies include downside risk protection for yields, prices and total revenue for a given crop. Downside protection can be provided by using the futures and/or options markets to protect price, using price and/or yield protection alternatives available with the new “Combo” policy insurance product for an insurable crop, or using some combination of all of these alternatives to protect price, yield and total crop revenue.

The software, as distributed, shows an example of a text book world, i.e., everything works out exactly as planned. In this example, expected production equals actual production and the Hedge in the futures market works out exactly as anticipated when the hedge is implemented.

This example allows you to follow the numbers through the various alternatives and see before and after results. Using this example helps understand how the software works and simplifies the inherent complexity of comparing Combo Policy Plans side-by-side with Futures and Options in a comprehensive risk protection strategy. Real world scenarios are also provided.

There are three distinct periods of time covered by the analysis in this software. In order to get accurate comparisons of the alternative strategies, the user must enter information relevant for a possible alternative risk protection strategies available at the time that strategy is implemented.

The first time period is just before the sales closing date for a particular crop. At this time, the RMA Projected Harvest Price for the Combo Insurance Plans is known. Once the published RMA Projected Harvest Price is entered it should not be changed unless an analysis of a different crop or location, causes the RMA Projected Harvest Price to change.

The second time period covers several months after the sales closing date for the crop being analyzed. Futures and Options market prices can vary a great deal during this time period. This variation can provide opportunities for implementation of risk management strategies utilizing Futures or Options contracts in addition to the purchased Combo Policy Plan. Remember that the Revenue Protection Plan (RP) offered with the Combo Policy also allows participation in upward trending prices up to 200% of the Projected Harvest Price available prior to the sales closing date. The second time period allows the flexibility to implement strategies for multiple layers of risk management protection, if the markets provide this opportunity.

The third time period is around harvest time. Typically the ending date for insurance coverage and the dates that futures contracts must be offset or options contracts are either exercised or expire worthless will differ by as much as a month, and possibly longer. In addition to the variation in the time periods for the Combo Policy, Futures and Options alternatives, producers can add another time period as they do not always sell the crop at harvest time, however, this software assumes the crop is sold at harvest time.

If you are using this software prior to knowing price levels set by the RMA Combo Policy or alternative price levels offered by the Futures and Options markets, we strongly recommend the you set all prices at the same level. After a risk management strategy is implemented and the production process and insurance period is over, it is highly unlikely that all price levels will be as predicted, before the fact. We caution you to make sure the set of variables entered have a relatively high probability of being achieved or the results will not be accurate.

Figure 1. Screen capture of the Introduction Tab for Combo Policy, Futures and Options Risk Protection Analysis Software while running inside Internet Explorer (IE) version 8.

Figure 2. Screen capture of the Introduction tab of the software, without the browser.

This software requires a browser to run. The screen capture in Figures 2 is shown without the browser just to maximize the image size in this document. All of the remaining figures are also shown without a browser to maximize the image size.

Figure 3. Screen capture of the General Inputs tab in the software.

The General Inputs tab, Figure 3, in this software contains the information needed to start an analysis. This information is broken into two groups. The first group is related to the Combo Insurance Policy. This information is collected for the three time periods described earlier. The first is sometime just prior to the sales closing date for a given commodity when the RMA Projected Harvest Price is known for that commodity. The APH Yield and the Acres Insured will also be known. The user can select a Yield Election percentage for each Combo Plan. The price election percentage for the Yield Protection plan can also specified. A premium for each type of Combo Insurance Plan must also be specified. Premiums can be estimated for any crop and

location using the RMA “Cost Estimator”. This calculator is located at:

http://ewebapp.rma.usda.gov/apps/costestimator/ To evaluate Futures and Options contracts on their own or in conjunction with a particular Combo Policy Plan, you can enter the Strike Prices and Premiums for Puts and Calls. While Combo Policy plans must be purchased prior to specific sales closing dates, which vary by crop and location, initiating an additional level of price protection with Futures or Options can happen up to several months after a Combo Insurance Policy is purchased. This time period is the second time period. At the time a second level of price/revenue protection is put in place, futures/options prices may differ substantially from the RMA Projected Harvest price, which is also based on the Futures/Options markets at the time it is specified.

Only at harvest time, the third time period, will the final results of a particular risk management strategy become clear. Insurance coverage for a Combo Policy Plan ends and any position(s) in the futures market are offset. Indemnity payments for Combo plan alternatives are determined by the relationship between the RMA Projected Harvest Price and the RMA Harvest Price.

Indemnity payments may vary by the specific Combo Policy Plan selected. This software allows you to explore the values of variables where Combo Policy Plans provide the same payment and factors that cause indemnity payments between plans to diverge.

In addition to any indemnity payments received from RMA, if a second tier of price/revenue protection was implemented using Futures and/or Options contracts, additional profits, or losses, may have been incurred. This software allows analysis of possible combinations of Combo Plans with Futures and/or Options contracts to provide a comprehensive analysis of risk management strategies.

The Futures Tab:



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