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T

WeighingFarmBillImpact

THE WORLD ACCORDING TO FLINCHBAUGH

“A $4 billion ag 

budget won’t buy a 

large farm program. 

Producersmust come 

to grips with this 

reality, and acquire 

the skills needed to 

manage risk.”

he 1996 Farm Bill will soon come under official scrutiny. Not only by a multitude 

of farmers, bureaucrats and ag advisors, but by the Commission on 21st Century 

Production Agriculture. The Commission was mandated by the Federal 

Agricultural Improvement and Reform Act (FAIR) to review the impacts of the legislation and to make recommendations for future agriculture policy.

According to Barry Flinchbaugh, a Kansas State Research and Extension economist, “the commission will assess the ways in which production flexibility contracts have served American 

farmers; the economic risks that small, medium and large farm operators face; the security of 

the nation’s food supply; farmland values and farm income; the success of ag regulatory relief 

and tax relief for farmers; and federal interference in ag export markets.

“Our first analysis will set the stage for our second mission,” said Flinchbaugh. “That mission 

is to review the past, present and future of U.S. production agriculture and assess and determine the proper role for the federal government.”

Initially,the Commission will consider five options:

(1) continuing Freedom to Farm beyond 2002 with a $4 billion baseline budget,

(2) ending federal farm programs altogether,

(3) reverting to a 1990 style farm bill,

(4) installing a completely new farm program that likely would be based on revenue based 

insurance plans, and

(5) reverting to the 1949 Agricultural Act.

“We won’t really know how to judge Freedom to Farm until 2000, when program payments 

decline significantly,” Flinchbaugh said. “This Commission isn’t going to focus strictly on 

Freedom to Farm. We are going to conduct an analysis of all available farm policy options.

This isn’t going to be a political road show.

“A $4 billion ag budget won’t buy a large farm program. Producers must come to grips with 

this reality, and acquire the skills needed to manage risk.”

WEIGHING FARM BILL IMPACT • 1
Contents

3 Stuck

A tongue-in-cheek look at the reasons producers don’t actively 

manage price and yield risk. Do any of these reasons sound 

familiar to you?

4 Taking Stock of Your Options

Begin the mind numbing, but necessary, task of formulating 

your risk management plan by thinking through your options.

An effective plan requires that contracting and forward pricing 

decisions be coordinated with production and borrowing decisions.

6 Painting the Risk Management Landscape

How do you manage risk on your farm? Does it matter? Read 

exciting new survey results to find out. Then, Discover Your Inner 

Farm by taking our quizzes to assess your management skills and 

financial strength. The results may shock you.

9 A New Crop of Insurance

Revenue insurance and other innovative strategies transform 

plain ol’ crop insurance into what farmers need to manage 

agricultural risks.

11 Price . . . It’s What You Make It

Come on down and learn how you can reduce price risk using 

storage, forward cash contracts, puts, minimum price contracts, 

hedge-to-arrive, and futures.

14 The Write Stuff

Bushels of publications, Internet sites, etc. you can turn to for 

information and educational materials.

2 • BUILDING A RISK MANAGEMENT PLAN
F

TOP TEN REASONS WHY 

FARMERS DON’T MANAGE RISK

Stuck

CHANGE IS GOOD...YOU GO FIRST

arm Futures magazine recently published a list ofthe top 

ten reasons why farmers don’t actively manage agricultural risk. Do any ofthese strike a chord with you?

As much as farmers have heard about the need to do a better 

job of analyzing their risks, developing a business plan, andhoning marketing skills,the number of farmers who have taken the 

first step is very small. In a survey of 960 readers conducted by 

FarmFutures, only about 5 percent are using available tools to 

manage production and financial risks.

So, why haven’tthe other 95 percent signed on? At leastfour 

reasons come to mind right away, which may help explain why 

producers are “stuck.”

1. Resistance to change. In what may be the ultimate irony, 

learning about risk management seems risky itself. It involves 

changing the way you approach decisions and the way you do 

business. Ifyoubelieve that change isunnecessary,the riskmanagement advice you’ve received in the past probably stung for a 

moment then blew past you like an arctic chill.

2. Too many decisions, not enough time. The variety of 

risk managementtools can be a curse as well as a blessing. Good 

tools incorrectly used or poorly understood can ruin an operation.Ongoing risk management and education will be necessary 

to stay competitive.

3. Oldfearsdiehard. Despitethefactthatthousandsofpeople use futures and options everyday to protectthemselves from 

price risk, distrust of the futures industry still runs deep in the 

hearts of many farmers. The crop insurance industry has also 

struggled to gain farmer confidence. Both industries are working 

with educators and farm organizations to increase trust and understanding.

4. The check is in the mail. Last but notleast, upuntilnow 

the Federal farm program absorbed some of the harsh realities associatedwithfarming.TheFederalGovernmentassumedpartof 

the production risk by making annual disaster payments. For the 

most part, those have been replaced with subsidized crop insurance. In the past, part of the marketing risk was reduced by annual price support payments. The safety net was held by Uncle 

Sam. Now, private sector alternatives to government programs 

must be understood and used.

In today’s marketplace, individual members ofthe financial, 

futures and crop insurance industries offer producers many complementary risk management tools. For producers, the reward for 

adopting risk management strategies may well be survival.

10. There’s no free cap or jacket

9. I’m waiting for my neighbors to try it

8. The media created El Niño

7. Crop failures build character

6. It’s more fun to keep my lender guessing 

about my ability to repay

5. I probably deserve a total crop loss

4. Sleeping too soundly would make my 

spouse wonder . . .

3. The IRS would take the profits 

anyway

2. My children would just fight over the 

estate

1. Life would be dull without daily doses of 

fear

SOURCE: FARM FUTURES

STUCK • 3
R

TakingStock ofYour

Options

THINGS TO DO WHEN YOU’RE NOT IN THE FIELD

EGARDLESSOFTHEENTERPRISE,whetheritiscropproduction, livestock feeding, or commodity storage, good management requires that contracting and forward pricing 

decisions be coordinated closely with production and

borrowing decisions (seenextpage).These suggestedsteps provide 

a general guide, as no single approach is bestfor every farmer.The 

choicedepends onthe individualfarmer’s resourcesandobjectives.

Identify Production, Borrowing, and 

Marketing Alternatives

The first step is to identify alternatives, which depend on the 

resources the farmer controls and the amount that the farmer 

can borrow. A crop farmer, for example, could grow different 

crops on the available land, lease more land, lease land to someone else, or even leave land idle. Similarly, the livestock feeder 

can place differenttypes and weights of livestock on feed, feed to 

different weights, or leave the feedlot empty. Different levels of 

cultural practices, fertilizer application, pest control, feeding 

rates, and so forth, may be possible.

The farmer’sborrowingalternatives dependontheamount of 

collateral owned and on lenders’ policies. Alternatives include 

the amountto borrow and whether to use long-term or shortterm loans.

The selling or contracting alternatives include the various 

outlets and types of cash, futures, and options contracts discussed 

in this report. Prices that potential buyers bid for cash contracts 

shouldbecomparedwithfuturespriceswherepossible,usingthe 

appropriatebasis.Ifdirectuseoffuturesoroptionsiscontemplated,thencommissionfees andmarginrequirements shouldbe assessed, and lenders’ policies in covering futures margin calls 

should be determined.

EstimateCostsandReturnsUsingForward 

Price Information

Forfarmerswithfixedinvestmentsinland,equipment,or farming 

skills, a shortrun goal is to maximize expected returns above variablecosts,subjectto some restraintonrisk.Expectedgrossreturns 

canbe basedon futures or cashforwardprices.Variable costs, such 

aspurchasedfeed,fertilizer,andchemicals,forexample,aredirectlytiedtoproductionandcanbeavoidedbynotproducing.Inthe 

long run,the farmerwants returns to exceed total costs, bothfixed 

and variable. But, profit is maximized or losses minimized in the 

short run by maximizing returns above variable costs.

Certain items that are fixed costs for one producer may be 

variable costs for another. For example, depreciation, interest, 

insurance,andtaxes onafeedlot are fixedcosts for the feedlot 

owner — they are realized whether the feedlotis used or not. 

However,the costs for these feedlot services are variable costs for 

the farmerwho ishiringcattle customfedinafeedlot.

Evaluate Risk and Risk-Bearing Capacity

Amongthe risks that a farmermustweighareprice risks, output 

risks, and risks of contract default by opposite parties. In past 

years, Government nonrecourse loans and deficiency payments 

effectively limited downward price risks for growers of programsupported commodities. The farmer who was eligible for loans 

and deficiency payments often needed no other price protection. 

Price risk has become more important with lower loan rates and 

target prices, and other farm program changes.

All crop producers face output risk, butthe risks are particularly great in nonirrigated areas that are subject to frequent 

droughts. Crop yield risk includes not only the possibility of low 

yields but also poor quality; for example, high-moisture corn, 

weak-fiber cotton, or undersized potatoes. Diversification among 

enterprises, cropinsurance,andholdingofreservefunds tocarry 

the farm through one or more bad crop years are the primary 

ways to deal with crop yield risk. In many crop-growing situa4 • BUILDING A RISK MANAGEMENT PLAN
tions, forward selling no more than a third or half of the expected crop before yield is assured minimizes risk.

Farmerswho enter cashcontractsmustalso consider thepossibility ofdefaultbybuyers;farmerswhouse futuresandoptions 

contracts must evaluate their basis risks, and farmers who hedge 

with futures must weigh the risks of margin calls. Dealing only 

with reputable buyers and sellers can limit default risk. Basis risk 

is relatively smallformost producers, but may be substantialfor 

farmers who are distantfrom futures delivery points or who produce commoditieswithspecialqualityattributes.Tobeprepared 

for futures margin calls, the farmer must either hold cash reserves 

or make arrangements with alender.

Farmers differ greatly intheamount of risk they cantolerate 

in an enterprise, depending on their overall debt-to-asset situation,their degree of diversification, and the riskiness oftheir 

other enterprises. One large loss, or two or three successive 

smaller losses, could throw intobankruptcy a specialized farmer 

with a high ratio of debts to assets. Such a farmer would wantto 

make full use offorward sales, option contracts, yield insurance, 

and other precautions to assure some minimum level of return. 

Incontrast,afarmerwithsubstantialfinancial reserves or other 

sources of income may choose to carry greater risks on a particular enterprise in hopes of achieving higher average returns over 

time. However, even the more financially secure farmer can use 

forwardcontracts oroptions toexpandprofitopportunitieswhile 

controlling risks.

Plan Borrowing, Production,and 

Marketing Activities

Once alternatives have been identified, costs and returns have 

been estimated, and risks evaluated, a coordinated plan for borrowing, production, and marketing can be developed. The plan 

needs to allow for the possibility of unfavorable contingencies, 

suchas lower thanexpectedprices oryields. Asound plancan 

also help in obtainingloans.

Implementation

Implementation involves arranging loans, obtaining insurance, 

buyinginputs,andcontractingforoutputs,andthencarryingout 

the physical processes of production and marketing. Changes in 

yield and price prospects after implementation begins may require modifying the plan.For example,the amount of a cropthat 

is forward priced can be adjusted upward or downward as yield 

prospects improve or decline.

TAKING STOCK OF YOUR OPTIONS • 5

STEPS IN FARM 

DECISION MAKING

Planning stage

1. Identify the production, borrowing, contracting, and spot-selling alternatives available.

2. Estimate costs and returns using forward price 

information.

3. Evaluate risks and risk-bearing capacity.

Implementation stage

1. Arrange loans, purchase inputs, and contract 

outputs.

2. Initiate and carry out production or storage.

3. Adjust to new information about price and 

yield prospects as needed.

4. Deliver the product, close out any futuresor 

option hedges, and repay loans.
TABLE 1

Risk Management Practices

(% using technique a lot)

69% Used government farm program

39% Diversified operation by raising crops and 

livestock

6%

2% Rented equipment rather than bought

SOURCE: FARM FUTURES

R

PaintingtheRiskManagement

Landscape

ASSESS YOUR MANAGEMENT SKILLS AND FINANCIAL STRENGTH

ECENT SURVEYS by Farm Futures questioned farmers 

onanumber oftopics ranging from their knowledge 

of pricing tools to their farm’s financial strength. The 

surveyproducedsomeilluminatingfindings,severalof

1989, 45 percent answered correctly. And, while only about a 

quarteruseoptions,thisfigurehasdoubledsince1989.

which are summarized below in Table 1. Almost 70 percent of 

those surveyed manage risks through farm program payments, 

which will end in the year 2002.

According to Farm Futures, few farmers appear to be putting 

it alltogether and actively trying to control the risks on their 

farms throughacoordinatedplan.Thoughthenumber of producerswithwrittenmarketingplanshasincreased,thispractice

has been adopted by just one inseven farmers, according to 39% Varied maturity dates of seeds

Farm Futures research. And, as Table 2 shows, few farmers ap- 35% Used contract inputs to lock in a good price

peartobeusinganalyticaltoolslikeratiosandaccrualaccount- 30% Bought crop insurance

ing although many of which are now computerized. 25% Used crop-share land rents

The advent of many new risk management tools has made 

farming even more challenging. Moreover, many different pri20% Kept a credit line open to take advantage of

attractive prices on inputs

vate sector companies offera piece ofthe risk management puzzle, 16% Used multi-year leases

butthereisno one-stopshoppingoutletavailablewhenit comes 13% Irrigated

toriskmanagement. 10% Shared expenses with landlord

8% Refinanced loans to take advantage of

lower interest rates Marketing Skills Hired custom operators to improve timeliness

A Farm Futures marketing skills test confirmed the assumption

thatfarmers who scored higher were also more likely to have 

achieved above-average profitability, as measured by return on

equity, over the lastfive years. It was also encouraging to see

6%

3%

of crop operations

Hired custom operator to reduce machinery 

expense

Diversified by raising crops not normally grown

that between 85 percent and 95 percent correctly answered 

questions relating to essential topics such as basis. 3%

in the area

Leased equipment rather than bought

Moreover,between68percentand83percent correctlydefined options terms such as a put, a call, a strike price, and a premium (see Table 3). When similar questions were asked in

6 • BUILDING A RISK MANAGEMENT PLAN
Turn the Page for a Risk Management Quiz

“One of the most troubling aspects 

of this survey research was that 

some 20 percent of today's

full-time farmers are vulnerable, 

burdened by debt and without 

adequate cash flow and profitability”

As encouraging as these findings are, research also shows

thatformany farmers the educationalprocess is onlybeginning.

Only 6 percent of those surveyed scored an A on the marketing

test, answering 18 or more of the 20 questions correctly. And 60

percent ofthe respondents received a score of 70 percent or less.

In addition, another recent survey demonstrated that risk

managementmeansmorethanmanagingpricerisk.Whenfarmersweresurveyedonotherpractices,few(just5percent or so)

qualified as first-rate risk managers, using a wide spectrum of

financial, production and marketing tools to control their overTABLE 3

KnowledgeofOptionsTerms

(% correctly identifying a term)

Aug. 1989 Sept. 1996 % Increase

Strike price 44% 79% +35%

Put 41% 68% +27%

Call 42% 68% +26%

Premium 45% 83% +38%

all level of risk while achieving outstanding returns.

One ofthe mosttroubling aspects ofthis survey research was 

that some 20 percent oftoday’s full-time farmers are vulnerable, 

burdened by debt and without adequate cash-flow and profitability. Indeed, a majority, some 55 percent, had substantial levels ofdebtbuthadnotyetadoptedthe riskmanagement skills 

needed to ensure their farm’s survival.

TABLE 2

Financial Risk Management Tools

(% using tool)

SOURCE: FARM FUTURES

Research indicates that educational efforts need to extend 

beyond one-dimensional approaches to risk management, 

which address strictly marketing fundamentals or crop insurance. Instead,farmersneedtounderstandall components of risk 

and be able to puttogether comprehensive risk management 

plans. By using this knowledge, farmers can indeed improve 

their profitability and prosper in this new era of free-market agriculture.

How does your farm rate? We’ve included two short quizzes 

to help you gain some perspective. First, measure your knowledge and use of risk management tools. Then, rate your farm’s

55% Cash-flow statements financial strength. You may be surprised.

46% Computerized financial records

24% Financial ratios

19% Accrual accounting

SOURCE: FARM FUTURES

PAINTING THE RISK MANAGEMENT LANDSCAPE • 7
Quizzes toDiscover Your Inner Farm

Risk Management SkillsAssessment

1. Mark if you’ve done the follow- Negotiatedmulti-yearleasesof 4. What percentage of your crops 6. Which of the following best

ing “a lot,” “some,” or “not farmland. are forward priced before harvest describes your approach to

much.” Give yourself 1 point for Used crop share leases.

each time you answer a lot, 2 Refinanced debt to take advantage

or before reaching market weight?

Subtract the number of pointsindicated

planning?

Add the number of points indicated.

points for each some, and 3 points 

for each not much.

 Diversified production by raising 

both crops and livestock.

of lower interest rates.

2. Subtract one point for each of 

the following techniques you use.

for both crops and livestock,giving 

yourself two separate scores.

 Crops

 Livestock

 Points Approach

1 = Have a detailed,

written plan for the 

next five years

 Diversified production by raising a Sensitivity analysis 

crop not widely grown in your area. Accrual accounting

 Planted varieties with different Cash flow plan 

maturity dates. Accountant

 Hired fieldwork done rather than Computerized financial records 

purchase a pieceof equipment. Financial ratios

 Hired fieldwork done to improve Financial consultant orfarmbusiness

2 = Put a few ideas on

paper, but nothing 

comprehensive

3 = Have a general idea, 

but nothing in 

writing

timeliness of crop operations.

 Used irrigation to reduce lossesfrom 

drought.

 Contracted inputs ahead of when

association

3. How many individual sales of 

your major crop will you make in a

5. If you raise livestock, what 

percent are raised orsold through a 

contract or marketing arrangement

4 = Have not doing any

planning that far into 

future

you needed them to lock in a good

price or made sure you’d have 

access to them.

 Bought crop insurance.

 Maintained a larger open line of 

credit than you need just in case.

 Participated in the governmentfarm 

program.

 Leasedequipmentratherthan 

purchased it.

 Rented equipmentratherthan 

purchased it.

 Sharedproduction expenses orwork 

with landlord.

year?

Subtract the number of pointsindicated.

Points Individual sales

1 = One

2 = Two to five

with a packer or other company? TOTAL POINTS

Subtract the number of points indicated 

for both hogs and cattle, giving yourself 

two separate scores.

 Hogs

Financial StrengthQuiz

 What letter grade (A, B, C, D, or F) would you give to judge the Compared to other farms, is your farm successful?

financial strength of your farm?

Put the number of points indicated below, ‘A’ being the best.

If no, put minus -1 point. Otherwise put zero.

A = 5 B = 4 C = 3 D = 2 F = 1 Over the next five years, do you expect your earnings to increase?

If no, put minus -1 point. Otherwise put zero.

 How likely is it that your farm could survive a year of bad yields or

bad prices — “very likely,” “somewhat likely,” or“very unlikely?” What were your farm’s total profits after expenses last year?

Put -1 point if you answered “very unlikely.” Otherwise put zero.

 How much would the following affect your farm? Answer “a lot,” 

“some,” or “not much.”

 a 3 percentange point rise in interest rates

 a 5% drop in revenues

 a 5% increase in expenses

Put -1 point for each time you answer “a lot.” Otherwise put zero.

 Do you worry about whether you’ll be able to pay back the debt you 

own?

If yes, put -1 point. Otherwise put zero.

 _Do you always pay offthe balance on your credit cards on time to 

avoid paying a finance charge on the outstanding balance?

If no, put minus -1. Otherwise put zero.

Put the number of points indicated below.

1 = Lost money

2 = Less than $10,000 

3 = $10,000 to $24,999

4 = $25,000 to $49,999

5 = $50,000 to $99,999

6 = $100,000 or more

 What is your farm’s debt-to-asset ratio? That is, your total debt 

divided by your total assets? %

Subtract the number of points indicated below.

1 = Zero (no debt) 

2 = 1 to 10%

3 = 11 to 40%

4 = 40 to 60%

5 = More than 60%

8 • BUILDING A RISK MANAGEMENT PLAN

Points % forward priced

1 = None

2 = 1% to 24%

3 = 25% to 49%

4 = 50% to 75%

5 = More than 75%

3 = Six to 10 Cattle 25 to 34 ★★

4 = 11 to 15 19 to 24 ★★★

5 = More than 15 Points % using contract 18 or less ★★★★

1 = None

2 = 1% to 24%

3 = 25% to 49%

4 = 50% to 75%

5 = More than 75%

SCORING SYSTEM

35ormore ★

SCORING SYSTEM

Zeroor less ★

Onetothree ★★

Fourtosix ★★★

Seven or more ★★★★
B

A New Crop of

Insurance

NEW WAYS TO PROTECT YOUR BOTTOM LINE

ECAUSE CROP INSURANCE MUST be purchased well before 

planting,making aninformed decisionis crucialto executing 

a risk management strategy. The choices producers make or 

don’t make will affecttheir ability to confidently price a percentage oftheir crop before harvest.Withcrop insurance, producers can 

markettheinsuredportionoftheir cropwithconfidence.Theyknow 

that they will have either the crops to deliver or insurance indemnities 

topurchasethecommoditiesnecessarytomeetdeliveryobligations.

For most producers, guaranteeing revenue is the bottom line of all 

risk management strategies. To that end, the U.S. Department of Agriculture’s Risk Management Agency (RMA) has made available three 

forms of revenue insurance that extend the coverage to include fluctuations in price. Each type combines yield and price risk protection into 

a single cropinsuranceplantoprotect croprevenue.Whilerevenue 

insuranceisnotasubstituteforamarketingplanandother risk-reducing farming techniques,the increased protectionis a welcomed change 

for many producers.

1. Income Protection

Income Protection (IP) policies protect producers against reductions

in gross income when either a crop’s price or yield declines from earlyseason expectations. Using corn as an example, a projected price, using

the February average of the December ChicagoBoard of Trade

(CBOT) corn contract, is used to establish guaranteed revenue. (The

revenueguaranteeequalstheproductoftheproducer’shistoricalyield,

the projected price, and the coverage level selected by the producer.)

Revenue shortfall is determined by using a harvest price, which is 

the November average ofthe same December contract.

The price at which the crop actually sells is not used to calculate 

a loss payment. A producer is paid for a loss when the actual and appraised yield multiplied by the harvest price falls belowthe revenue 

guarantee. Other crops use similar pricing periods as specified in the 

crop insurance policy.

For example, suppose that a cornproducerhas anaverage historical 

yield of 115 bushels per acre,the projected price is $2.50 per bushel, 

and the producer selects 75 percent coverage. The producer’s revenue guarantee is $215.63 per acre (115 bu. x $2.50 x .75). Using the

informationabove,the following two scenarios illustrate conditions 

under which IP would pay producers:

Low yields/High prices

The producer harvests only 55 bushels per acre, butthe harvest 

price is $2.60 per bushel. The producer’s calculated revenue is

$143 per acre (55 bushels x $2.60 per bushel).

So, the producer is paid the difference of $72.63 per acre 

($215.63 - $143).

Normal yields/Low prices

The producer harvests 115 bushels per acre, butthe actual harvest price falls to $1.80 per bushel. The producer’s calculated 

revenue is $207 per acre (115 bushels x $1.80 per bushel).

So, the producer is paid the difference of $8.63 per acre 

($215.63 - $207).

The premium for IP coverage reflects the historic yield variation 

and the variation in gross income due to yield and price movements 

during the crop year.

2. Crop Revenue Coverage

Like the Income Protection plan, Crop Revenue Coverage (CRC)

provides revenue protection based on price and yield expectations. 

CRC, however,pays for losses belowthe yield guarantee atthehigher of an early-season price or the harvest price. For most corn, the 

early-season price is 95 or 100 percent of the February average daily 

settlement price of the CBOT December corn futures contract. The 

harvest priceis 95 or 100 percent of the November average daily settlement for the same December contract. The price at which the 

crop actually sells is not used to calculate a loss payment. 

Commodity exchanges, measurementperiods, andcontractmonths 

may vary for other crops.

The CRC revenue guarantee equals the product of the producer’s historical yield, the coverage level, and the higher of the earlyseason price or the harvest price.

For example, suppose that a cornproducerhas anaveragehistorical 

yield of 115 bushels per acre,the early-season price is $2.50 per

A NEW CROP OF INSURANCE • 9
“Because cropinsurancemustbepurchasedwellbeforeplanting,making 

aninformeddecisioniscrucialtoexecutingariskmanagementstrategy. 

The choices producers make—or don’t make—will affect their ability to 

confidently price a percentage of their crop before harvest”

bushel ($2.63 x .95), and the producer selects 75 percent coverage. 

Using this information, the following two scenarios illustrate the 

conditions under which CRC would pay producers:

Low yields/Harvest-time priceis higherthan theearly-season price 

Theproducerharvests55bushelsperacre,andtheharvesttimeprice (November)increases to$3.00perbushel.So,the 

producer’s dollar amount of protection is $245.81 per acre (115 

bu.x.75x$2.85[.95x$3.00]).Thecalculatedrevenueis

$156.75 (55bu. xtheharvestprice of$2.85).So,the losspaymentto the producer is $89.06 peracre ($245.81 - $156.75).

Lowyields/Harvest-timepriceislessthantheearly-seasonprice 

The producer harvests 55 bushels per acre, and the harvest 

price falls to $1.80 per bushel (.95 x $1.89).The producer’s 

minimum amount of protection is $215.63 per acre (115 bu. x

.75xthehigherof$2.50or$1.80)andthecalculatedrevenue 

is$99.(55 bu. x$1.80harvest price).So,the losspaymentto 

the producer is $116.63 per acre ($215.63 - $99).

On average, CRC premiums are significantly higher than IP 

premiums. The higher costis due in part to the higher price used to 

pay losses. Inaddition, IPcoverage is based onall of a producer’s 

acreage in a county, while CRC allows producers to subdivide their 

acreage into smaller “units,” as defined in their policies.

3. Revenue Assurance

Revenue Assurance (RA) is dollar-denominated coverage. That is,

a producer selects a dollar amount of target revenue from a range 

defined by 65 to 75 percent of expected revenue:

(approved APH yield x coverage level

x projected county price)

The projected county price is used to calculate the revenue guarantee and premium. The county harvest price is used only to determine the value of production to subtract from the revenue guarantee. The difference is the indemnity.

The projected county price for corn is a simple average ofthe 

final closing daily settlement prices in February on the December 

futures contractfor the current crop year, minus the county-specific adjustment factor. The county-specific adjustment factor is the 

historical difference between county harvest price and the simple 

average of the final daily settlement price in November on the 

CBOT December futures contract.

For soybeans,the projected county price is the simple average of 

the final closing daily settlement prices in February on the CBOT 

November futures contract for the current crop year, minus the 

county-specific adjustment factor. The county-specific adjustment 

factor is the historicaldifference between countyharvest prices and 

the simple average ofthe finaldaily settlement prices in October on 

the November futures contract. The projected county prices will be 

calculated before March 5 ofthe current crop year.

Thecountyharvestpricefor cornis theaverage oftheNovember 

daily cornposted countyprice for the applicable crop yearpublished 

byUSDA.For soybeans,itistheaverageoftheOctoberdailysoybean-posted county price. The county harvest prices will be calculatedby November5 ofthe current cropyear for soybeans andby 

December 5 for corn.

4.Energizing Multiple Peril Crop 

Insurance Protection

Federal crop insurance products are commonly called MultiplePeril Crop Insurance (MPCI). Two MPCI insurance plans are the Actual Production History plan (APH) and the Group Risk Plan 

(GRP). Both standard insurance plans canbe combinedwith various 

pricing tools to provide coverage that approximates revenue insurance 

protection.

For example, one cost-effective strategy might be to combine a

GRP policy with maximum coverage and a put option. GRP coverage is adeparture fromtraditionalapproaches to cropinsurance because it uses an index the expected county yield as the basis for protection. When the county yield for the insured crop falls below the 

yield level chosen by the producer,the producer receives a loss payment. GRP buyers can insure up to 90 percent of the expected 

county yield at up to 150 percent of the expected price at rates generally lower than traditional APH protection.

GRP might be a good risk management tool for producers who

(1) can’tordon’twantto furnishindividual yieldrecords to establishAPH guarantees,(2)have individualfarmyields that vary with 

county yields, or (3) determine that the cost of insuring crops with 

APH exceeds the perceivedrisks.

Using this strategy, a 1997 soybean loss triggered by low county 

yields may be paid at a high value per bushel (1997 county soybean 

losses could be paid in excess of $10 per bushel). This policy provides a high level of price protection in case of county crop loss. 

Theput optionpurchased beforeplanting is likely tohave increased 

in value if there was a large national soybean crop, thus giving the 

producer downside priceprotection.

10 • BUILDING A RISK MANAGEMENT PLAN
A

Price

It’sWhatYouMakeIt

PROVEN WAYS TO PROTECT YOUR PRICE

SK MOSTFARMERSabout risk and one wordprobably 

comes to mind: debt. The 1980s farm financial crisis 

vividlyillustratedwhathappenswhenyoucan’tpay 

offthe money you’ve borrowed to buy land, machinery,andcropinputs.Even10years later,bankruptcy,foreclosure, 

and the loss of the family farm remain powerful warnings of the 

risks of leverage. Yet producers face another big threat to their 

business income and stability: price risk.

Whether it’s stored grain or the crop you’ll plant in the 

spring, not having price protection puts you at risk. If prices fall, 

your revenues also fall.

Some farmers can afford to take a lot of price risk. Farmers 

with little debt and strong earnings can wait until prices rally to 

sell their production. And if prices fall—well, they’ve got more 

than enough money to putin another crop and do it again. By 

taking a lot of price risk they may increase the ultimate rewards 

they coax from themarket.

But most farmers don’t have the luxury of waiting for the 

market. The risk from weather and debtis just about allthe risk 

they can afford to take. Fortunately, there are plenty of ways to 

reduce price risk. Here’s a rundown ofthe most popular riskreducing tools farmers areusing.

Since 1985, farmers have been able to trade options on commodity futures. Agriculture options convey the right to buy or sell a 

specific futures contract at a set “strike price.” In exchange for 

that right,thebuyerofanoptionpays thesellerafee orpremium. Agriculture options don’t last indefinitely; they usually 

expire a week or two before the beginning of the delivery month 

for the futures contract they involve.

A put option is the opposite of a call. It’s the right to sell a 

specified futures contract at a specific strike price. If futures are 

higher than that price, the put is “out of the money” and not 

worth much. If futures are lower than the put’s strike price, the 

putis “inthemoney” andworth more because it couldbe exercised and the resulting futures position closed out for an immediate profit.

Anoptionto sellfutures is aput option.For example, a

farmer who pays a 10-cent premium and buys a December $3

corn put owns the rightto sell December futures for $3 a bushel.

If prices are higher than $3, that right obviously isn’t worth

verymuch. If prices are lower than $2.90,the option could be

exercised immediately for a profit.

Forward cash contract

Withthis agreement, sometimes called fixed or flat price contract, you lock in a final price for a commodity you’re either storing or expect to raise. You can forward contract the commodity 

that’s growing in the field to lock in a good price from a summertime weather scare rally. You can also forward contract stored 

inventory,using a post-harvest rally to price the crop you’ll store 

until the river system opens, for example.

A risk minimizing approach is to fix both the futures and 

basis portions ofyourprice atthe same time,witha forwardcash 

contract when a portion of your production is known. Basis is 

the amount your cash price differs from the futures price.

Minimum price contract

Just as elevators have begun offering cash contracts based on 

futures, they have designed agreements using options.

Under a minimum price contract, you sell grain to the elevator for a fixed price, less the cost of a call option you select. If 

prices rise, you may be able to add to your selling price. Ifthe 

marketdoesn’t rise,you’re guaranteedtheminimumprice.

These prices can be used both before and after harvest. Specific details vary: some elevators let yousellthe optionandfix 

your price at any time, while others require holding the option 

until expiration. Some ofthese contracts fix the basis; others 

combine the call with a hedge to arrive.

PRICE: IT’S WHAT YOU MAKE IT • 11

Buy a put option
Average Daily Closing Price

$2.65

$2.60

$2.55 not here!

$2.50

$2.45

$2.40

$2.35

Jan 3 Mar1 Apr 27 Jun23 Aug 21 Oct 17 Dec 13

...

The best marketing opportunities 

normally occur before harvest.

Althoughmostfarmers stillprefer to buyoptions througha broker,these option-derived cash contracts have carved out a niche.

Hedge-to-arrive

These cash contracts fix the futures portion of your price, butlet

you spotthe basis later.They contain the potential for a lot of

flexibility.For example, youcanclose outasale inone futures

contract month and then sell again inanother month.This “rolling” feature lets you seek additional basis gains; you can also profit onthe spread, ordifference, betweenfutures contract months.

Of course, too much flexibility can be dangerous, as farmers

and elevators found out in 1996. When the spreads between old

and new crop futures soared twice as high as ever before, hedgeto-arrive contracts incurred huge losses for farmers who had

priced 1996 and 1997 corn crop with 1995 crop futures.

Because of the problems, many elevators have instituted 

tighter controls over their hedge to arrive contracts. Rolls are 

limited to the same crop year as the original hedge, and you may 

have to pay the elevator the equivalent ofmargin money iffutures prices rise.

Sell futures

Fixing futures andbasis atthe same timehas onedrawback.The 

futures and cashmarkets arenot always strong atthe same time 

because basis changes. It reflects the cost of storing a commodity 

until the delivery period and transporting it to the delivery site 

set by the futures contract.Demand also figures in.The more 

customers needthe crop,themore they’rewillingto payfor it, 

strengthening the cash market and the basis. By contrast, when 

a commodity is plentiful (for example, at harvest), storage and

transportation costs increase, and supply overwhelms the demand—

all factors that weaken the basis.

As a result, fixing the futures and basis parts of your price at 

different times may help you realize a higher overall price. One 

way to do this is to sell exchange traded futures contracts directly through a broker. This is what your elevator does to hedge its 

risk after it forward contracts grain with you.

Futures contracts list a delivery month and a quantity. For 

example, 5,000 bushels atthe Chicago Board of Trade and 1,000 

bushels at the Mid-America Commodity Exchange. But, very 

few contracts are ever exercised. Instead, buyers and sellers of 

grain use the contracts as surrogates to lock in a price for the 

commodity.Then,they offsetthe position—a seller buys back 

the previous sale—and add or subtract any profits or losses from 

the price they negotiate in the cash market.

Totradefutures,youmust startanaccountwithafuturesbroker and deposit margin money to guarantee each position you 

open. If your position shows a loss, you must deposit more funds 

on a dollar-for-dollar basis. You’ll also incur commissions and 

exchange fees every time you open a position.

Financingafuturesaccount canbeamajorobstacle,especially ifyouintend to staywith ahedge allthewayuntil harvest, and 

prices rise significantly after you initiate the futures sale. Some 

banks provide funds for hedges; many don’t.

Usingfuturesdirectly,however,givesyougreaterflexibilitythan 

cash instruments.For example,if youwantto store after harvestto 

waitforbasistostrengthen,youcouldsellfuturesonspringandsummer rallies,then buy back the positions later (at harvest),when 

prices are typically lower. You’d then be free to waitfor a cash marketrallyortohedgeagaininacontractmonthforlaterdelivery.

Moreover, selling with a cash contract commits you to delivering the commodity. Ifit begins to looklike your yields might 

come up short, you can’t simply cancel the contract as easily as 

you can with a futures position.

12 • BUILDING A RISK MANAGEMENT PLAN
“Most farmers don’t have the luxury of waiting 

for the market (until prices are high).

The risk from weather and debtis just about 

all the risk they can afford to take.”

Farmers oftenhave opinions about 

prospective changes in prices of the 

commodities they produce or buy.For 

example, a farmer may expect the 

priceof cornforDecemberdeliveryto 

rise or fall as harvest approaches. If a 

price rise is confidently expected,then 

the farmermightwantto wait and sell 

the crop after harvest. If the price is 

expectedto fall,alargerthannormal 

forward sale may be desirable.

Farmers have both advantages 

and disadvantages compared with

other traders when it comes to anticipating price changes. 

Farmers are often the firstto observe local weather and yield 

developments. However, few farmers have the time and expertise 

to perform thorough price analyses themselves, nor the funds to 

hire the best professional advice.

Price forecasting methods fall into two categories: fundamental analysis and technical analysis. Fundamental analysis involves 

identifying and evaluating the factors that affect the supply and 

demand for a commodity and assessing their effects on price. 

Fundamental analysis ranges from informal assessment of the 

effects of the latest news on prices to the use of elaborate statistical models. The information needed for fundamental analysis of 

agricultural prices includes planting, weather, numbers of livestock raised or on feed, production, stock, exports, and general 

economic conditions. The U.S. Department of Agriculture collectsand disseminatesmuchofthis informationinits cropand 

livestock production reports.

Technical analysis involves searching for patterns in price 

movements that repeat over time. The objective is to recognize a 

pattern as it begins to develop, and to trade accordingly. The traditional method is to plotthe price series on a chart and watch

for patterns. Another common approach is to search for trends by comparing the latest price with a moving 

average of past prices. Computers 

greatly facilitate the use of technical 

price forecasting methods. A number 

offirms sell chartsofdailycommodity 

futures prices, and manybooks on technical analysis are available. However, 

the usefulness of technical analysis for 

commodity price forecasting is a subject of continuing debate. Because 

many technical price forecasting methods rely on the application of individual judgment, their performance is difficult to evaluate. The wide use of technical analysis 

bytradersmayitselfintroducepatternsinpricemovements.

Any proposed price forecasting method or trading rule should 

be examinedcriticallybeforeitisused.Eventhebestpriceforecastingmethodsare likelyto bewrongoruselessmuchofthe time.

Storage

Your grain bins are one ofthe most basic risk management tools 

onyour farm.Byholding grainatharvest, youavoid selling right 

off the combine, when prices typically are weakest. Many farmers store atleast halftheir crops, selling them in increments. 

Selling a little at a time over the year also increases the odds 

you’ll getanaverageprice—another riskmanagement strategy.

The downside to storage, of course, is that it costs money, 

whether you use farm bins or the elevator in town. Some years 

prices don’t rally afterharvest,and oftenthebest prices ofthe 

year come during the growing season.

PRICE: IT’S WHAT YOU MAKE IT • 13
The Write

Stuff

Extension Service Materials

Managing Change/Managing Risk: 

A Primer for Agriculture

13 articles by ISU staff

Send $4 to Iowa State University 

c/o C. Phillip Baumel 

Department of Economics

460 Heady Hall

Iowa State University 

Ames, IA 50011

Check with your local extension office or contact the state 

Extensionservicelistedforthefollowingpublications.

Charting the Markets G91-1051-A to G91-1059-A 

University of Nebraska-Lincoln

Distribution Services 

105 Ag. Comm. Bldg. 

Lincoln, NE 68583-0918

Phone: (402) 472-3023

E-mail: agcm017@unlvm.unl.edu

Also available electronically at:

http://www.ianr.unl.edu/pubs/

Deferred Pricing Alternatives for Grain NCR217-2 

($2.00)

University of Illinois 

1401 S. Maryland Dr. 

Urbana, IL 61801

Phone: (217) 333-2007

E-mail: oacepubs@uiuc.edu

Use of Crop Futures and Options 

by the Nontrader NCR217-18

NorthDakotaStateUniversity 

Extension Communication 

Box 5655, Morrill Hall

Fargo, ND 58105

Phone: (701) 237-7882

E-mail: slane@NDSUext.NoDak.edu

14 • BUILDING A RISK MANAGEMENT PLAN

AnIntroduction toCommodity Futures 

Markets and ContractsMF-982

Developing A Crop Marketing Plan

— An Integrated Approach C-688

The Cash/Futures Price Relationship MF-1003

Cross Hedging Agricultural Commodities NCR217-12 

Kansas State University 1989

Production Svcs., Distr. Ctr 

16 Umberger Hall

Manhattan, KS 66506-3402

Phone: (913) 532-5830

E-mail: orderpub@oz.oznet.ksu.edu

Wheat Marketing Strategies EXEX 5022 

South Dakota State University

Ag. Communications Center 

Box 2231, SDSU

Brookings, SD 57007-0892

Phone: (605) 688-5628

E-mail: am02@sdsumus.sdstate.edu

Seasonal Cash Price Patterns for Selling 

Corn/Soybeans/Wheat NCR217-03 

Marketing Strategies & Recordkeeping

on Corn/Soybeans/Wheat NCR217-04

Cost of Grain Storage Producer 

Marketing Management NCR217-19

Technical Analysis Producer 

Marketing Management NCR217-20

Michigan State University 

Bulletin Office

10-B Ag. Hall

East Lansing, MI 48824-1039 

Phone: (517) 355-0240

E-mail: anrcs@msue.msu.edu

Cash-Futures Price Relationships: 

Guides toCorn MarketingP93-1

University of Minnesota 

MES Distribution Center 

1420 Eckles Ave.

St. Paul, MN 55108-6069 

(612) 625-8173

E-mail: orders@mes.umn.edu
Do You Need a Market Advisory Service NCR217-14 

Primer on Agricultural Options NCR217-1 

University of Wisconsin

630 W. Mifflin St. 

Room 170

Madison, WI 53703

Phone: (608) 262-3346

E-mail: carol.pollock@mail.admin.wisc.edu

Introduction to Agricultural Marketing and

Plan Your Marketing: Enhance Profits and 

Reduce Risk from PM-1284 ($27.00 + $6.20 S&H)

A publications catalog is available free of charge by sending 

a mailing address to:

Iowa State University 

Publications Distribution 

Printing & Publishing Bldg. 

Ames, IA 50011-3171

Phone: (515) 294-5247

E-mail: pubdist@exnet.iastate.edu

Managing Risk in Agriculture NCR 406 

Cooperative Extension Service

Purdue University

AgComm Svc, MediaDist Ctr 

301 S. Second Street 

Lafayette, IN47901-1232

Phone: (317) 494-6794

E-mail: juanita@ecn.purdue.edu

Multimedia

Audio/Visual for Rent

VH-3513-GO Business Managementin Agriculture: 

Managing Risk

Audio/Visual for Sale

VH-5592R-GO Business Managementin Agriculture: 

UnderstandingBasis$15.00+$4.00S&H

VH-5591R-GO Business Managementin Agriculture: 

Using Agricultural Options $15.00 + $4.00 S&H

VH-5590R-GO Business Managementin Agriculture: 

UsingFuturesMarket$15.00+$4.00S&H

Minnesota Extension Service 

MES Distribution Center

20CoffeyHall,1420EcklesAve. 

Saint Paul, MN, 55108-6069 

(612) 625-8173

E-mail: orders@mes.umn.edu

Commodity Exchanges

How To Market Your Wheat 

Selecting a Commodity Broker

Understanding and Using Basis for Grains 

The Minimum Price Contract

— A New Marketing Alternative

KansasCityBoard ofTrade 

4800MainSt.Suite303 

KansasCity,MO64112

Power of Options Workbook 

Minneapolis Grain Exchange 

Suite 130, 400S. 4thSt.

Minneapolis, MN 55415

(800) 827-4746 or (612) 321-7101

E-mail: mcarlson@mgex.com

Crop Yield Insurance Futures and Options EM15-7 

Pricing Crop Yield Insurance Options Program EM15-7A 

Understanding Basis EM12-4

TheFlexibleChoice:HedgingwithCBOT 

Agricultural Options EM13-8

The FlexibleChoice: TradingwithCBOT 

Agricultural Options EM13-9

Grain Futures and Options EM11-5

Soybean Complex Futures and Options EM11-6

Introduction to Hedging with Futures and Options

EM15-5

Options on Agricultural Futures: 

A Home Study Course EM11-3

Marketing Clubs: A Hands-on Approach 

to Marketing EM11-10

Chicago Board of Trade 

Publications Department

141 W. Jackson St. Suite 2210

Chicago, IL 60604-2994

(312)435-3558 or (800)THE-CBOT

Internet Sites

Extension market news and commentary

http://etcs.ext.missouri.edu:70/1/agebb/mkt

University of Missouri Agricultural Electronic Bulletin Board

http://www.oznet.ksu.edu/dep/agec/pub.htm

Kansas State University

http://www.ag.uiuc.edu/~stratsoy/weekly.html

Weekly Outlook Report Home Page

http://ssu.agri.missouri.edu/ssu/fapri/fapri.htm

FAPRI Home Page

http://www.exnet.iastate.edu/Information/market.html

Iowa State University

THE WRITE STUFF • 15
The Write Stuff (continued)

USDA/Government Internet sites

http://www.usda.gov/rma/rme

Risk Management Education

http://www.noaa.gov/

National Oceanic and Atmospheric Administrations

http://www.usda.gov/nass/

National Agricultural Statistics Service

http://www.usda.gov/

USDA’s Home Page

http://www.ams.usda.gov/marketnews.htm

Agricultural Marketing Service Market News reports

http://www.fas.usda.gov

Foreign Agricultural Service

http://usda.mannlib.cornell.edu/usda/usda.html

USDA Economics and Statistics System

http://www.econ.ag.gov/

Economic Research Service

http://www.esusda.gov/statepartners/usa.htm

CooperativeStateResearch,Education,andExtensionService

http://www.cftc.gov/cftc/

Commodity Futures Trading Commission

Commodity exchanges/marketing advisors

http://www.cbot.com/mplex/

Chicago Board of Trade Market Plex

http://www.cme.com/market/aglinks.html

Chicago Merchantile Exchange Resource Center

http://www.mgex.com/why/didnt.htm

Minneapolis Grain Exchange tutorials

http://www.kcbt.com/

Kansas City Board of Trade

http://www.agribiz.com/

Market information from Frank Beurskens Consulting, Inc.

http://www.steward.peterson.com/agednet.htm

AgEd Network lessons from Stewart-Peterson Advisory Service

16 • BUILDING A RISK MANAGEMENT PLAN

Books

Bernstein, Jake. The Investor’s Quotient: The Psychology of 

SuccessfulInvesting inCommodities & Stocks. 2nd ed. 

John Wiley & Sons,1980.

Bobin, Christopher A. Agricultural Options: Trading,

Risk Management, and Hedging. John Wiley & Sons, 1990.

Caplan, David. The Options Advantage. Probus Publishing 

Company, 1991.

Chicago Board of Trade. Commodity Trading Manual. 1989.

Purcell,WayneD.Agricultural Futures and Options:Principles 

and Strategies. MacMillan Publishing, 1991.

Information Sources

Government and private sources provide information 

needed for making contracting decisions.

Federal-State Market News Reports

The Federal-State Market News Service originates much of the 

available data on agricultural cash prices and marketings, covering 

all ofthe major commodities. Market news reporters collect price 

quotations by observing trades or talking with buyers and sellers 

face-to-face or by telephone. For many commodities, price quotations are released to news media daily or at regular times within 

the day,and printed reports are mailed weekly from market news 

offices throughout the country. Most of the quoted prices apply to 

spot ornear-termdelivery rather thancontracts fordeferred delivery, although some deferred delivery prices are reported. Radio, 

television,andnewspapersaswellaselectronicquotationservices 

widely carry the Market News prices. Some farmers may find it 

worthwhile to subscribe to the printed reports. Information about 

theFederal-State Market News Service is available from:

Agricultural Marketing Service

U.S. Department of Agriculture 

Washington, DC 20250

National Agricultural Statistics Service Reports

USDA’sNationalAgriculturalStatisticService estimatesacreage, 

production, stocks, inventories, and related data for most crops 

andlivestock.Estimatesarereleasedthroughouttheyearon 

prescheduled dates.Thenewsmedia summarize the most significant statistics ineachreport.Commoditytraders followthese 

releases closely,andmarkets oftenrespondtoactualoranticipated 

information in the reports. The summertime crop estimates are 

particularly important in the grain and soybeanmarkets. The table 

on page 17 lists the reports and shows how to order them.

Economic Research Service Situation and Outlook Reports 

USDA’s Economic Research Service produces situation and outlook reports in a dozen commodity areas, plus reports on exports, 

income and finance, inputs, trade, and an overall Agricultural 

Outlook report. These reports combine statistics from various 

sources with written interpretation to provide readers with background for making production and marketing decisions. The commodityreportsareissuedregularly,typicallythreetofourtimesper 

year. Agricultural Outlook is published 10 times a year. A list of the 

situation and outlook reports is provided on page 18.