Taking Charge of Managing Risk on Your Farm March 12, 2002 Moonraker Restaurant Marshall

1. Taking Charge of ManagingRisk on Your FarmMarch 12, 2002Moonraker Restaurant Marshall

2. Let’s start by testing how you think about risk: Which would you prefer? • 80% chance you will win $4,000 20% chance you get $0 B. Win $3,200

3. How about a downside choice: Which would you prefer? C. Lose $3,200 • 80% chance you will lose $4,000 20% chance you lose nothing.

4. Summary: A. 80% chance you will win $4,000; 20% Zero B. Win $3,200 C. Lose $3,200 D. 80% chance you will lose $4,000; 20% Zero Most people answer B and D

5. • In the 1st “lottery,” the average was the same for both choices: + $3,200. 80% x $4,000 + 20% x $0 vs $3,200 for sure • In the 2nd “lottery,” the average was the same for both choices: (- $3,200). 80% x (- $4,000) + 20% x $0 vs (- $3,200) for sure • Most respondents were willing to give up upside potential. But, they kept downside risk.

6. We tend to be inconsistent in our risk perceptions and choices: • On one hand, many overreact to eye-catching, low probability events. • On the other hand, we tend to ignore unlikely, low probability price and yield events when making plans. It won’t happen to me!

7. Research Suggests: • We tend to spend too much on more routine “hits” that, while unpleasant, can be coped with ... • But we often don’t pay enough enough attention to protecting against big hit, low probability events.

8. Summary: • How we “frame” information and choices tends to keep us from making pricing and insurance choices that are as good as they can be. • The consequences of these biases can be significant! • Biases are normal. One focus of this workshop is designed to help you keep them from getting in the way of making good decisions.

9. Decision Making Environment • Do you have written goals for your farming operation? • Are you meeting your Goals?

10. Basic Goals Include... • Generating sufficient net income to support a comfortable “family income draw” from the farm business • Ensure the financial survival and profitability of the farm business

11. And, ... • Have high level of satisfaction from the farm business • See growth in farm business net worth • Maintain financial ability to take advantage of business opportunities

12. But, farms must contend with ... • Ups and downs in the economic climate • Lousy weather … that reduces yield, quality, or the ability to get in the field • Changes in the USDA safety net

13. Let’s review some recent history • Are there lessons that we can draw?

14. Corn futures: the long view

15. Reality Check I • Did the $5.00 spike in corn prices cloud your neighbors judgement in pricing 1998 corn? 1999? 2000? 2001? • Did your neighbor “bet” on a drought in Iowa and Illinois in 1998? On drought in the western corn belt in 1999? On the “Drought of 2000”?

16. What did the market say in March ‘98? • 50-50 bet was CBOT harvest futures contract on corn at $2.70 / bu • One chance in 3 of $2.50 or less • One chance in 12 of $2.10 or less

17. On the up side: • One chance in 3 of CBOT corn futures at harvest exceeding $2.90 /bu • One chance in 5 of corn exceeding $3.10 • One chance in 12 of corn over $3.50

18. Summary of the market’s estimate of price risk exposure in early March ‘98

19. What did the market do 1998?

20. Were There Lessons From 1999? What About 2000 and 2001? 2002 ?

21. Reality check II • Are yields more or less variable than annual average prices? • Do farmers responses match what their records show? • For most farms, yield risk exposure is real

22. Chances of alternative corn yields: a review of the last 50 years for a Gratiot Co. Farm

23. Reality check III • On the average, over the last 27 years, there has been a 5¢ to 15¢ premium for pricing in the late spring-early summer weather market • But, I don’t pre-harvest price because of yield risk, contract delivery exposure

24. Check? • Is the yield risk exposure large enough to keep you from selective pre-harvest pricing? • Are there other ways to get around yield risk exposure concerns?

25. Changes... • USDA no longer attempts to balance supply and demand with Acreage Reduction Programs • Grain stock holding decisions are now in the private sector • But, LDP’s may effect farmer’s timing of sales.

26. How do prices respond to ending stocks?

27. Taking Charge of Managing Your Risks: Goal = Increase Profitability and Ensure Financial Survival

28. Today’s workshop will... • Help you identify and clarify how to manage your financial risk exposure • Develop options that could improve your profitability and reduce the risk exposure in your operation

29. Today’s workshop will... • Help you structure your information on: • Your capacity to bear risk • Revenues, required to cover: • Cash flow requirements • Maintain current level of equity • Review the risk control tools that are available • Use these “tools” in a “hand’s-on” case study – so you can use them on your farm

30. END