1. Econ 338C, Spring 2009 ECON 338C: Topics in Grain Marketing Chad Hart Assistant Professor/Grain Markets Specialist chart@iastate.edu 515-294-9911

2. Econ 338C, Spring 2009 Today’s Topic Farm Financials & Homework #1

3. Econ 338C, Spring 2009 Homework #1 1.Hedging: Holding equal and opposite positions in the cash and futures markets. 2.In a hedge the net price will differ from your expected price only by the amount that the actual basis differs from your expected basis. 3.With a put option, the buyer pays the premium and has the right, but not the obligation, to sell a futures contract at the strike price. 4.With a call option, the seller receives the premium and is obligated to sell a futures contract at the strike price if the buyer uses their right. 5.With a call option, the buyer pays the premium and has the right, but not the obligation, to buy a futures contract at the strike price. 6.What is the most common reason crops fail? Drought

4. Econ 338C, Spring 2009 Homework #1 7. Expected Local Hedged Price = Futures Price + Expected Basis – Commission CornSoybeans Futures Price $4.2725 $8.92 Expected Basis-$0.25-$0.25 Commission-$0.01-$0.01 Expected Local Hedged Price $4.0125 $8.66 Cash Price = Final Futures Price + Actual Basis Return from the Hedge = Initial Futures Price – Final Futures Price – Commission Net Price = Cash Price + Return from the Hedge

5. Econ 338C, Spring 2009 Homework #1 7. b)7. c) Final Futures Price $3.75 $9.75 Actual Basis-$0.10-$0.65 Cash Price $3.65 $9.10 Initial Futures Price $4.2725 $8.92 Final Futures Price-$3.75-$9.75 Commission-$0.01-$0.01 Return from the Hedge $0.5125-$0.84 Cash Price $3.65 $9.10 Return from the Hedge $0.5125-$0.84 Net Price $4.1625 $8.26

6. Econ 338C, Spring 2009 Homework #1 8. a) Floor Price = Strike Price + Basis – Premium – Commission Strike Price $8.20 Expected Basis-$0.25 Premium-$0.6325 Commission-$0.01 Floor Price $7.3075 8. b) A futures hedge (short hedge) or buying any put option at or above a $4.90 strike price will work. Futures HedgePut Option Futures Price $4.2725Strike Price $4.90 Expected Basis-$0.25Expected Basis-$0.25 Commission-$0.01Premium -$0.97125 Net Price $4.0125Commission -$0.01 Net Price $3.66875

7. Econ 338C, Spring 2009 Homework #1 8. c) Buying any call option with a strike price at or below $7.40 will work. Ceiling Price = Strike Price + Basis + Premium + Commission Strike Price $7.40 Expected Basis-$0.25 Premium $1.85875 Commission $0.01 Net Price $9.01875

8. Econ 338C, Spring 2009 Call Option  The Buyer pays a premium and has the right, but not the obligation, to buy a futures contract at the strike price.  The Seller receives the premium but is obligated to sell a futures contract at the strike price if the Buyer uses their right.

9. Econ 338C, Spring 2009 Buying a Call Option

10. Econ 338C, Spring 2009 Selling a Call Option If futures > strike, Cash – Premium + Commission + Option Payout If futures < strike, Cash – Premium + Commission Option Payout = Futures price – Strike price

11. Econ 338C, Spring 2009 Homework #1 9. a) Insurance Payment = $4.00/bu * (65% * 200 bu/acre – 122 bu/acre) = $32 per acre Insurance Premium = $3.13/acre (from slide) Net Insurance Payment = $32.00 – $3.13 = $28.87 9. b) Insurance Payment = (65% * 200 bu/acre * $4.04/bu – 122 bu/acre * $3.90/bu) = $49.40 per acre Insurance Premium = $5.17/acre (from slide) Net Insurance Payment = $49.40 – $5.17 = $44.23

12. Econ 338C, Spring 2009 Financial Terms Cash Flow – The difference between cash revenues and expenses moving through the business Net Worth – Value of assets versus liabilities in the business Income – The difference between total revenues and expenses moving through the business

13. Econ 338C, Spring 2009 Estimated 2009 Iowa Corn Costs Source: Duffy and Smith, http://www.extension.iastate.edu/agdm/crops/pdf/a1-20.pdf

14. Econ 338C, Spring 2009 Estimated 2009 Iowa Corn Costs Source: Duffy and Smith, http://www.extension.iastate.edu/agdm/crops/pdf/a1-20.pdf

15. Econ 338C, Spring 2009 Estimated 2009 Iowa Corn Costs Source: Duffy and Smith, http://www.extension.iastate.edu/agdm/crops/pdf/a1-20.pdf Short run, need to cover cash flow costs Seed, fertilizer, chemicals, rent, insurance, etc. Cash flow costs vary by structure Cash renter, Share renter, Owner Farmer choices: Fertilizer, crop insurance

16. Econ 338C, Spring 2009 Estimated Iowa Corn Per Acre Costs Source: Duffy and Smith, http://www.extension.iastate.edu/agdm/crops/pdf/a1-21.pdf 200720082009 $ per acre Machinery Costs100.83108.48114.38 Seed, Chemicals, and Fertilizer197.55238.67352.71 Labor29.2929.15 Land155.00190.00205.00 Total482.67566.30701.24 Bushels per acre Expected Yield156157 $ per bushel Cost per Bushel3.103.624.48

17. Econ 338C, Spring 2009 Estimated Iowa Soy Per Acre Costs Source: Duffy and Smith, http://www.extension.iastate.edu/agdm/crops/pdf/a1-21.pdf 200720082009 $ per acre Machinery Costs46.7648.5055.80 Seed, Chemicals, and Fertilizer107.58126.06202.85 Labor26.95 Land155.00190.00205.00 Total336.29391.51490.60 Bushels per acre Expected Yield50 $ per bushel Cost per Bushel6.737.839.81

18. Econ 338C, Spring 2009 Cash Flow Costs Cash Flow Costs: the cash expenses paid to produce and market the crop Land ownership structure affects cash flow costs Renter, owner, crop-share Managerial decisions also affect cash flow costs Crop insurance Fertilizer Etc.

19. Econ 338C, Spring 2009 Cash Flow Costs: Renter vs. Owner 200720082009 $ per bushel Corn Renter3.103.624.48 Owner2.102.403.16 Soybean Renter6.737.839.81 Owner3.634.035.71 Land rent is a cash flow issue for renters. Land owners do not face that cash flow cost.

20. Econ 338C, Spring 2009 Outlining Cash Flow Needs What is your production plan? Source: Edwards, http://www.extension.iastate.edu/agdm/crops/pdf/c3-15.pdf

21. Econ 338C, Spring 2009 Outlining Cash Flow Needs What are your cash inflows? Source: Edwards, http://www.extension.iastate.edu/agdm/crops/pdf/c3-15.pdf

22. Econ 338C, Spring 2009 Outlining Cash Flow Needs Source: Edwards, http://www.extension.iastate.edu/agdm/crops/pdf/c3-15.pdf

23. Econ 338C, Spring 2009 Outlining Cash Flow Needs Source: Edwards, http://www.extension.iastate.edu/agdm/crops/pdf/c3-15.pdf Monitoring cash needs within and through the year A positive cash flow for the year does not imply the farm can not get caught in a cash flow squeeze

24. Econ 338C, Spring 2009 Items to Consider for Cash Flow  Production plan  Inventory on hand  Input requirements for production  Estimated income from production  Estimated income from other sources  Estimated expenses for production  Debt service  Non-farm related income and expenses

25. Econ 338C, Spring 2009 Net Cash Flow for Assignment

26. Econ 338C, Spring 2009 Current Assets and Liabilities Source: Edwards, http://www.extension.iastate.edu/agdm/crops/pdf/c3-20.pdf Current assets – cash or assets that can be converted to cash quickly Current liabilities – debts that are due in a short time

27. Econ 338C, Spring 2009 Fixed Assets and Liabilities Source: Edwards, http://www.extension.iastate.edu/agdm/crops/pdf/c3-20.pdf Fixed assets – assets that will not be sold and are needed to maintain production Fixed liabilities – debts that are due in a long time

28. Econ 338C, Spring 2009 Farm Net Worth Source: Edwards, http://www.extension.iastate.edu/agdm/crops/pdf/c3-20.pdf Farm Net Worth = Farm Asset Value – Farm Liabilities Working capital = Current Assets – Current Liabilities  Potential cash to cover additional expenses

29. Econ 338C, Spring 2009 Key Ratios Source: Edwards, http://www.extension.iastate.edu/agdm/crops/pdf/c3-20.pdf Current Ratio = Current Assets/Current Liabilities  Measures ability to pay debts in the short term  Ratio of 2 or higher indicates good ability  Ratio of 1 or lower indicates possible issues Debt-to-Asset Ratio = Total Liabilities/Total Assets  Measures credit load versus asset value  30% to 40% is a common value for Iowa farms  Farming can be an expensive livelihood and loans often provide the means of conducting it

30. Econ 338C, Spring 2009 Net Income Source: Hofstrand, http://www.extension.iastate.edu/agdm/crops/pdf/c3-24.pdf Income and expenses cover cash and non- cash related transactions. Profits and cash flow are not the same thing.

31. Econ 338C, Spring 2009 Iowa Averages, 1998-2007 Source: Edwards, http://www.extension.iastate.edu/Publications/FM1845.pdf

32. Econ 338C, Spring 2009 Iowa Averages, 1990-1998 Source: Edwards, http://www.extension.iastate.edu/Publications/FM1845.pdf

33. Econ 338C, Spring 2009 Iowa Averages, 1998-2007 Source: Edwards, http://www.extension.iastate.edu/Publications/FM1845.pdf

34. Econ 338C, Spring 2009 Iowa Corn Prices vs. Costs Source: USDA-NASS and Duffy and Smith, http://www.extension.iastate.edu/agdm/crops/pdf/a1-21.pdf

35. Econ 338C, Spring 2009 Iowa Soybean Prices vs. Costs Source: USDA-NASS and Duffy and Smith, http://www.extension.iastate.edu/agdm/crops/pdf/a1-21.pdf

36. Econ 338C, Spring 2009 Knowing Your Farm Financials …Provides you several targets for your marketings Do prices cover your cash expenses, meeting your cash flow needs? Do prices cover your total expenses, providing profit and adding to your net worth? On the production side, we often compare yields to trend; on the marketing side, we need to compare prices to per-unit costs.

37. Econ 338C, Spring 2009 Class web site: http://www.econ.iastate.edu/classes/econ338C/Hart/ See you next week! Have a great VEISHEA! http://www.econ.iastate.edu/classes/econ338C/Hart/