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 1 1

Corn Prices vs. Costs

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

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

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

Ego Greed Fear

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.

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

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

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

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

Seasonal Pattern

Pre-Harvest Strategies 56% 52% 52% 52% 72% 68% 68% 68% With strong prices for 2011 crops, pre-harvest price opportunities are great right now. And pre-harvest strategies generally work well as the graph shows. Some years they do not pan out (see for example 2010), but 2011 looks to be a good year. 72% 68% Source: Farm Futures magazine

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

Futures and Options 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

Summary on Options Buyer Seller Buying puts Buying calls 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

Average Price Captured

Lowest Average

Highest Average

Longer History

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 Expected Change Basis Strengthens Hedge Hedge to Arrive Put Options Cash Sale Forward Contract Futures Decrease

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

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

Federal Crop Insurance

Causes of Loss for Iowa Corn, 1948-2010

Causes of Loss for Iowa Soy, 1955-2010

Acres Insured in 2011 Corn and Soybeans--Iowa

Corn Insurance Prices

Current Subsidy Rates 60% 64% 80% 65% 59% 70% 75% 55% 77% 48% 68% 71% Coverage level Basic Units Optional Units Enterprise Units Whole Farm Units 60% 64% 80% not avail. 65% 59% 70% 75% 55% 77% 48% 68% 71% 85% 38% 53% 56%

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

Coverage Level Choice

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

Thank you for your time. Any questions. My web site: http://www. econ 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/