Managing Risk for Stability and Growth

Dr. Marin Bozic

MMPA/UMN-Extension Dairy Management WorkshopsFebruary 5-6, 2013

A real problem…

But it hurts to leave money on the table…

1/3/

2012

1/22

/201

2

2/10

/201

2

2/29

/201

2

3/19

/201

2

4/7/

2012

4/26

/201

2

5/15

/201

2

6/3/

2012

6/22

/201

2

7/11

/201

2

7/30

/201

2

8/18

/201

2

9/6/

2012

9/25

/201

2

10/1

4/20

12$15.00

$17.00

$19.00

$21.00 Class III Milk Futures: Oct 2012

Start with the end in mind.

• Retirement without debt?• Prevent catastrophic losses?• Gives me headaches, but necessary evil?• Chase the highs, beat the market? • Grow faster?

Three and a half strategies

1. Hedge early, hedge often.

2. LGM-Dairy

3. Farm bill

3.50. Hedging for growth

Hedge early, hedge often

Hedge early, hedge often

Hedge early, hedge often

Hedge early, hedge often

2006-2012 returns to at-the-money put options

1 month ahead:Cost: $0.19/buPayout: $0.16/bu

3 months ahead:Cost: $0.68/buPayout: $0.79

6 months ahead:Cost: $0.95/buPayout: $1.33/bu

9 months ahead:Cost: $1.13/buPayout: $1.59/bu

Hedge early, hedge often

LGM-Dairy

Feb Mar

Apr

May

Jun

Jul Aug

Sep

Oct

Nov

Dec

Jan

Purchase at End of

Month

No Coverage

1 2 3 4 5 6 7 8 9 10

Insurance Contract Period

LGM-Dairy

LGM-Dairy

LGM-Dairy

Farm bill

Warning: Results presented here are preliminary. Further research is needed before analysis of farm level impacts is tested enough to be presented publicly for policy analysis and debate purposes. Results presented here are given exclusively for participants of MMPA/UMN-Extension Dairy Management Workshops. No permission is granted or implied for disseminating these results further without explicit permission by Dr. Bozic.

Farm bill

Two alternatives:

Dairy Security Act Goodlatte-Scott

Amendment

Subsidized Margin Insurance

• Official name: Dairy Producer Margin Protection Program (PDMPP)

• Two layers: • Basic Margin Protection – No-cost protection

at $4.00 margin• Supplemental Margin Protection – Can buy up

from $4.50 to $8.00 margin in 50 cents increments (called “Coverage Level”)

Subsidized Margin Insurance

Subsidized Margin Insurance

Subsidized Margin Insurance

Subsidized Margin Insurance

House bill - Farm with 150 cows

Coverage Level

Fees & Premiums

Expected Indemnity

DMSP Penalty

Net Revenue

$4.00 250 5,369 5,828 -5,057$4.50 532 7,569 5,828 -4,235$5.00 954 10,390 5,828 -2,697$5.50 1,377 13,938 5,828 75$6.00 2,081 18,327 5,828 4,475$6.50 2,786 23,580 5,828 11,270$7.00 12,479 29,770 5,828 10,729$7.50 16,874 37,103 5,828 16,590$8.00 26,229 45,862 5,828 18,412

Comparing 6-Year Net Revenue for 450 cows farm:DSA vs. Goodlatte-Scott 2007-2012

Coverage Level

Goodlatte-Scott H.R. 6083 S. 3240

$4.00 53,432 -26,360 -29,360$4.50 26,238 14,033 9,215$5.00 66,179 57,439 54,065$5.50 98,927 93,776 84,948$6.00 125,325 120,895 124,033$6.50 138,807 152,012 127,198$7.00 158,003 77,805 14,525$7.50 -285 69,217 -23,200$8.00 -57,106 -25,607 -84,829

Hedging for Growth

Profits from hedging?• Good broker that can beat the market?• Mispriced Class III milk options?• Subsidized LGM-Dairy insurance?• Farm Bill participation?

But there is another strategy too…• Using risk management to grow your operation faster• With solid milk marketing plan that delivers stability, your

banker will be more willing to accept higher leverage

thank you

Managing Risk for Stability and Growth

presented at the Dairy Management Workshops

Tuesday, February 5, 2013St. Joseph, MNWednesday, February 6, 2013Rochester, MN

Dr. Marin Bozicmbozic@umn.eduDepartment of Applied EconomicsUniversity of Minnesota-Twin Cities

You may download this presentation at http://marinbozic.info/