1. USING FUTURES TO MANAGE RISK RICHARD BRIGGS RBC Dominion Securities

2. What is a Basis?  Basis Spot price of hedged asset - Futures price of contract  A negative number means futures above spot price. A positive number means spot price above futures.  Basis varies less then spot or futures prices

3. Basis  Spot prices reflect current conditions where as futures reflect anticipatory conditions  Seasonality may affect the basis Narrow basis occur during Aug-Sept period Increasing supply conditions Widening basis occur during Dec-Jan period Decreasing supply conditions  At futures maturity both prices will be about the same

4. Spot and Future Price -Daily Spot Price -Daily Future Price

5. Using Futures to Hedge Price Risk  Futures and Spot prices will move up or down together  Hedging involves taking the opposite side of the spot position  Remaining risk is Basis which has a lower risk profile then remaining un-hedged  CME Lean Hog contract is for 40000 lbs  Currency of contract is USD  Margin requirement per contract $1250

6. Hedging - Upward moving market DateSpot MarketFutures MarketBasis January 5 2012 Hedge is placed 81.40 87.55 cwt Sell 1 CME LH J2 81.40 - 87.55 -6.15 April 16 2012 Hedge is lifted 83.25 89.40cwt Buy 1 CME LH J2 83.25 – 89.40 -6.15 Operation in futures market results in loss of (87.55-89.40)x40000= -$740 usd per contract FINAL PRICE RECEIVED Spot Price + G/L on Futures Operation 83.25 – 1.85= 81.40 cwt

7. Hedging - Downward moving market DateSpot MarketFutures MarketBasis January 5 2012 Hedge is placed 83.25 87.55 cwt Sell 1 CME LH J2 83.25 - 87.55 -4.30 April 16 2012 Hedge is lifted 81.40 85.70 cwt Buy 1 CME LH J2 81.40 – 85.70 -4.30 Operation in futures market results in gain of (87.55-85.70)x40000= +$740 usd per contract FINAL PRICE RECEIVED Spot Price + G/L on Futures Operation 81.40 + 1.85= 83.25 cwt

8. How many contracts does one need to hedge? 1.Verify the impact of $1 cwt change in futures 2.Divide 400 by this (LH contract is 40k lbs, about 150 market ready pigs each penny change represents $400.00 3.This number represents the amount of contracts to place on your hedge Number of Pigs per 1 LH Contracts = 400 1 X % of futures used for pig price Example: finisher buys 100 feeder pigs for 85% of July LH futures price Number of Pigs per 1 LH Contracts = 400 1 X.85 Number of Pigs per 1 LH Contracts = 470

9. Using Options to Hedge  Using options is another way to hedge your production  Can sell calls or buy puts when prices falling  Can buy calls and sell puts when prices are rising  Can create neutral, bullish and bearish option strategies through options

10. Using Options to Hedge (cont’d)  Options can be combined with futures to enhance risk profile  Buying options to hedge = producer knows maximum cash outlay  Options provide flexibility in your hedge

11. Reasons to Hedge with Futures  Most Marketing contracts don’t have a fixed price  Many contractors use LH futures to determine a sales price  Usually restricted on how far out you can hedge your price  Can protect against un-priced physical  Producers can use futures to manage price risk  Flexible, offset at any time

12. Reasons to Hedge with Futures (cont’d)  Futures can be used to manage input price risk and currency risk  Basis may change but the reduction in risk through hedging outweighs being un-hedged.  Will enhance your credit profile with lenders  Flexible, offset at any time

13. Hedging no Panacea  Hedging does not always guarantee best selling price  Basis does change Quality of hogs Delivery location Time Contracts may not match exactly with production

14. Richard Briggs Tel# 1-855-602-4113 Email : richard.briggs@rbc.com RBC Dominion Securities RBC Dominion Securities Inc.* and Royal Bank of Canada are separate corporate entities which are affiliated. *Member- Canadian Investor Protection Fund. ®Registered trademark of Royal Bank of Canada. Used under licence. RBC Dominion S®Registered trademark of Royal Bank of Canada. Used under licence. RBC Wealth Management is a registered trademark of Royal Bank of Canada. Used under licence. ©Copyright 2011. All rights reserved.