Econ 338C, Spring 2009 ECON 338C: Topics in Grain Marketing Chad Hart Assistant Professor/Grain Markets Specialist

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

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

Econ 338C, Spring 2009 Homework #1 7. Expected Local Hedged Price = Futures Price + Expected Basis – Commission CornSoybeans Futures Price $ $8.92 Expected Basis-$0.25-$0.25 Commission-$0.01-$0.01 Expected Local Hedged Price $ $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

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 $ $8.92 Final Futures Price-$3.75-$9.75 Commission-$0.01-$0.01 Return from the Hedge $ $0.84 Cash Price $3.65 $9.10 Return from the Hedge $ $0.84 Net Price $ $8.26

Econ 338C, Spring 2009 Homework #1 8. a) Floor Price = Strike Price + Basis – Premium – Commission Strike Price $8.20 Expected Basis-$0.25 Premium-$ Commission-$0.01 Floor Price $ 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-$0.01Premium -$ Net Price $4.0125Commission -$0.01 Net Price $

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 $ Commission $0.01 Net Price $

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.

Econ 338C, Spring 2009 Buying a Call Option

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

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 = $ 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

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

Econ 338C, Spring 2009 Estimated 2009 Iowa Corn Costs Source: Duffy and Smith,

Econ 338C, Spring 2009 Estimated 2009 Iowa Corn Costs Source: Duffy and Smith,

Econ 338C, Spring 2009 Estimated 2009 Iowa Corn Costs Source: Duffy and Smith, 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

Econ 338C, Spring 2009 Estimated Iowa Corn Per Acre Costs Source: Duffy and Smith, $ per acre Machinery Costs Seed, Chemicals, and Fertilizer Labor Land Total Bushels per acre Expected Yield $ per bushel Cost per Bushel

Econ 338C, Spring 2009 Estimated Iowa Soy Per Acre Costs Source: Duffy and Smith, $ per acre Machinery Costs Seed, Chemicals, and Fertilizer Labor26.95 Land Total Bushels per acre Expected Yield50 $ per bushel Cost per Bushel

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.

Econ 338C, Spring 2009 Cash Flow Costs: Renter vs. Owner $ per bushel Corn Renter Owner Soybean Renter Owner Land rent is a cash flow issue for renters. Land owners do not face that cash flow cost.

Econ 338C, Spring 2009 Outlining Cash Flow Needs What is your production plan? Source: Edwards,

Econ 338C, Spring 2009 Outlining Cash Flow Needs What are your cash inflows? Source: Edwards,

Econ 338C, Spring 2009 Outlining Cash Flow Needs Source: Edwards,

Econ 338C, Spring 2009 Outlining Cash Flow Needs Source: Edwards, 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

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

Econ 338C, Spring 2009 Net Cash Flow for Assignment

Econ 338C, Spring 2009 Current Assets and Liabilities Source: Edwards, Current assets – cash or assets that can be converted to cash quickly Current liabilities – debts that are due in a short time

Econ 338C, Spring 2009 Fixed Assets and Liabilities Source: Edwards, Fixed assets – assets that will not be sold and are needed to maintain production Fixed liabilities – debts that are due in a long time

Econ 338C, Spring 2009 Farm Net Worth Source: Edwards, Farm Net Worth = Farm Asset Value – Farm Liabilities Working capital = Current Assets – Current Liabilities  Potential cash to cover additional expenses

Econ 338C, Spring 2009 Key Ratios Source: Edwards, 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

Econ 338C, Spring 2009 Net Income Source: Hofstrand, Income and expenses cover cash and non- cash related transactions. Profits and cash flow are not the same thing.

Econ 338C, Spring 2009 Iowa Averages, Source: Edwards,

Econ 338C, Spring 2009 Iowa Averages, Source: Edwards,

Econ 338C, Spring 2009 Iowa Averages, Source: Edwards,

Econ 338C, Spring 2009 Iowa Corn Prices vs. Costs Source: USDA-NASS and Duffy and Smith,

Econ 338C, Spring 2009 Iowa Soybean Prices vs. Costs Source: USDA-NASS and Duffy and Smith,

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.

Econ 338C, Spring 2009 Class web site: See you next week! Have a great VEISHEA!