ASSESSING RISK

1. ASSESSING RISK • RISK - THE POSSIBILITY THAT SOME LOSS MIGHT OCCUR. • WHAT ARE THE CAUSES OF RISK? • WHAT ARE THE EFFECTS OF RISK ON THE BUSINESS? • HOW CAN WE CONTROL RISK?

2. SOURCES OF RISK • PRODUCTION AND YIELD • MARKET AND PRICE • BUSINESS AND FINANCIAL • TECHNOLOGY AND OBSOLESCENCE • CASUALTY LOSS • SOCIAL AND LEGAL • HUMAN

3. PRODUCTION AND YIELD RISK VARIABILITY IN YIELDS AND PRODUCTION CAUSED BY FACTORS SUCH AS WEATHER, DISEASE, PESTS, GENETIC VARIATION, AND TIMING OF PRACTICES. • MARKET AND PRICE RISK VARIABILITY AND UNPREDICTABILITY OF PRICES

4. BUSINESS RISK SOURCES OF BUSINESS RISK ARE YIELD, OUTPUT PRICE, AND INPUT PRICES. BUSINESS RISK IS ASSOCIATED WITH CHARACTERISTICS OF THE BUSINESS. • FINANCIAL RISK THE RISK ASSOCIATED WITH FINANCING, MEETING FIXED FINANCIAL OBLIGATIONS.

5. TECHNOLOGY AND OBSOLESCENCE RISK. NEW TECHNOLOGY CAN MAKE CURRENT METHODS OBSOLETE. • CASUALTY LOSS LOSS OF ASSETS DUE TO FIRE, WIND, HALE, FLOOD, AND THEFT. • SOCIAL AND LEGAL RISK GOVERNMENT PROGRAMS AND REGULATIONS

6. HUMAN RISK THE CHARACTER, HEALTH, AND BEHAVIOR OF INDIVIDUALS.

7. RISK-RATED MANAGEMENT STRATEGIES • RISK-RATED MANAGEMENT STRATEGIES START WITH THE ASSIGNMENT OF PROBABILISTIC OUTCOMES. • EXAMPLE: BEST, OPTIMISTIC, EXPECTED, PESSIMISTIC, AND WORST. • THE EXPECTED OUTCOME IS THE ONE MOST LIKELY TO OCCUR. MOST LIKELY PRICE, YIELD, AND COSTS. • A SERIES OF CASH FLOW BUDGETS MAY BE PREPARED TO ASSES THE IMPACTS OF THE POSSIBLE OUTCOMES.

8. RISK MANAGEMENT RULES OF THUMB 1. THERE ARE NO CERTAIN PROFITS 2. HIGHER PROFITS TEND TO BE ASSOCIATED WITH HIGHER RISKS OF LOSS 3. THERE IS NO “BEST” STRATEGY 4. GOOD STRATEGIES IMPROVE THE ODDS OR CHANCE FOR SUCCESS

9. 5. DECISIONS SHOULD BE EVALUATED WITH RESPECT TO OBJECTIVES - NOT HINDSIGHT 6. GOOD DECISIONS SOMETIMES HAVE BAD OUTCOMES 7. GOOD STRATEGIES, OVER TIME, WILL PRODUCE GOOD RESULTS

10. BUSINESS RISK • THE RISK INHERENT IN THE FIRM, INDEPENDENT OF THE WAY THE FIRM IS FINANCED. • GENERALLY REFLECTED IN THE VARIABILITY OF NET OPERATING INCOME OR NET CASH FLOWS

11. SOURCES OF BUSINESS RISK • MARKET PRICES • INPUT PRICES • YIELDS • BR = σ1 / cx • WHERE, σ1 IS THE STANDARD DEVIATION OF NET CASH FLOWS WITHOUT DEBT FINANCING, AND CX IS THE EXPECTED NET CASH FLOWS WITHOUT DEBT FINANCING.

12. FINANCIAL RISK • THE ADDED VARIABILITY OF THE NET CASH FLOWS OF THE OWNERS OF EQUITY THAT RESULT FROM THE FIXED FINANCIAL OBLIGATION ASSOCIATED WITH DEBT FINANCING.

13. FINANCIAL RISK • FR = (σ2 / cx - I) – (σ1 / cx) • FR = TR – BR • WHERE, σ1 IS THE STANDARD DEVIATION OF THE NET CASH FLOWS WITHOUT DEBT FINANCING, σ2 IS THE STANDARD DEVIATION OF THE NET CASH FLOWS WITH DEBT FINANCING BUT BEFORE DEDUCTION OF DEBT SERVICING PAYMENTS, CX IS THE EXPECTED NET CASH FLOWS WITHOUT DEBT FINANCING, AND I IS FIXED DEBT SERVICING OBLIGATIONS.

14. FOR SIMPLICITY, THE ASSUMPTION IS MADE THAT (σ1 = σ2 ) • FINANCIAL RISK MAY BE RESTATED AS: FR = (σ1 / cx) * (I / CX-I)

15. THIS STATEMENT FOR FINANCIAL RISK INDICATES THAT FINANCIAL RISK IS DETERMINED BY THE DEGREE OF BUSINESS RISK INHERENT IN THE FIRM (σ1 / cx) AND THE RELATION (I / CX-I) WHICH IS DETERMINED BY THE FINANCING DECISION.

16. TOTAL RISK • TR = (σ1 / cx - I) OR • TR = (σ1 / cx) * (CX / CX-I) • A TOTAL RISK CONSTRAINT CAN BE STATED AS: TR = (σ1 / cx) * (CX / CX-I) ≤ β

17. RISK BALANCING • A CHANGE IN BUSINESS RISK FROM SOME EXTERNAL SOURCE, SUCH AS A CHANGE IN PRICE SUPPORT POLICY, COULD CHANGE THE LEVEL OF TOTAL RISK IF ALL OTHER VARIABLES REMAIN UNCHANGED. • FOR INSTANCE, IF PRICE SUPPORT PROGRAMS CHANGED WHEREBY THE LEVEL OF BUSINESS RISK INCREASED, THE LEVEL OF TOTAL RISK WOULD INCREASE.

18. IF THE LEVEL OF TOTAL RISK EXCEEDED THE CONSTRAINT LEVEL, ADJUSTMENT IN FINANCIAL RISK WOULD BE NECESSARY TO MAINTAIN TOTAL RISK AT THE CONSTRAINED LEVEL.