Efficient Cash and Hedged Enterprise Combinations in Feeder Calf Backgrounding Operations

Backgrounding of feeder cattle is a growing METHOD OF ANALYSIS specialty operation in the so-called "Fescue Belt" grasslands of the South (Bradford et al.). Portfolio analysis techniques are used to Backgrounding is largely a seasonal enterprise, evaluate the hedging of backgrounding operaconsisting of the purchase of weaned calves that tions. As its name implies, portfolio analysis are placed on pasture and supplemental feed for originated in financial security analysis for the several months and then resold for placement in purposes of determining the combination of sefeedlots. Since feeder calf and feeder cattle curities that would maximize returns for a given prices are among the most volatile of all classes amount of risk, or alternatively, minimize risk for of cattle, backgrounders face considerable price a given level of return (Markowitz). Markowitz risk (Russell and Franzmann). In principle, hedgdeveloped the concept of the efficient frontier, ing could shift this risk, but there has been a which consists of combinations of securities that question whether hedging can be worthwhile, meet these criteria. Portfolios that do not lie on given the additional costs and financial obligathe efficient frontier can be reorganized to intions involved. Size of operation is also a factor, crease returns or decrease risk without change in because the feeder cattle futures contract is indithe other measure. The efficient frontier consists visible. Profitable application of hedging requires of a series of portfolios rather than a single one, a balancing of risks and rewards from alternative because the choice of a particular combination combinations of hedged and cash backgrounding along the efficient frontier depends upon the inoperations to find the one best suited to the indidividual investor's utility function with respect to vidual manager's needs, given his price expectarisk versus reward. By providing information tions. Since individuals differ greatly in their reabout the makeup of the efficient frontier, the sponses to risk and also differ in their price exanalyst can facilitate decision making for many pectations, research on hedging application will investors without having to know their utility be most useful if it provides arrays of alternatives functions. from which to choose. This article demonstrates Portfolio analysis techniques are applied to how this can be done and assesses the potential backgrounding operations by budgeting altemademand for such information. That is, is it applitive production and marketing enterprises, and cable only to a few large farmers capable of abby determining the expected value and variability sorbing a contract, or can more substantial numof their rates of return (Musser et al.). bers be involved? Covariances among all alternatives are also rePrevious research on feeder cattle hedging in quired. Delimiting the number of alternatives is the South has included work on location basis crucial, because if the problem is approached as variability (O'Bryan et al.) and the development an investment decision in its largest sense, the of decision rules for selective hedging programs number of possible alternatives is virtually with(Franzmann; Russell and Franzmann). Selective out limit. The problem is made tractable by rehedging research has been concerned with restricting its focus to backgrounding operations turns and variances of alternative trading only. Efficient frontiers composed of backstrategies, but has ignored the problem of choice grounding enterprise combinations can then be among equivocal strategies. These strategies incomputed by means of quadratic programming, dicate that returns can be increased, however, using annualized rates of return and variances only at some increased level of risk, or vice and covariances of rates of return as input variversa. Choice among equivocal alternatives, or ables (Grunewald). more accurately, the analysis of them so that A number of different feeding systems can be farmers can make choices, is the object of this used in a backgrounding operation, ranging from research. confinement drylot to straight pasturage. Analy-