United Grain Growers - Syn 1 236b5w

Hanindita Guritna 29114713 Hussein Al-Muhtadeebillah 29114737 Felix Terahadi 29114744 Rini Amelia 29114857 Hidratul Fidic D 29114859

Background

Grain Distribution

Volatile Characterized by boom and bust cycle Variable supplies due to natural forces

Regulations Created to reduce fluctuations

Grain Distribution In Canada, Farmers sold “Board Grains” to the Canadian Wheat Board (CWB) to guarantee a floor price Grain Distributors like UGG were important intermediaries between the farmers and the end market Farmers hauled their grain to “grain elevators” and pays the handling fee The Big Players: Saskatchewan Wheat Pool (30%), Agricore (25%), and UGG (15%) UGG Revenues from this service (1999): $19/ tons from regulated and non-regulated grains

United Grain Growers

United Grain Growers (cont.)

The Willis Report 1992, shareholders successfully sued their directors because the firm did not hedge it's grain risk when prices were falling Emerging interest in risk management prompted UGG to participate in a benchmarking review of best risk management practices in its Treasury department

On site Risk Brainstorming

Willis Attention

Earnings at Risk (EaR) Which had been developed by the financial community, to describe aggregate risk

EaR expressed a "worst-case" loss, set against a benchmark of expected profit, within a specified confidence or probability level.

CHARM • CHARM (Comprehensive Holistic All Risk Model) generated graphical output in several formats to highlight the various aspect of each risk. • The most general format was a probability distribution showing the probability of incurring a loss as a function of the size of the dollar loss . • Cox had the information to do something to improve the firm's risk management performance and potentially reduce UGG's long term cost of risk

List of Risk Business Interruption

Employee Liability

Pension Plan Performance

Cargo / Marine Exposure

Employee Performance / Fidelity

Process Compliance / Execution

Civil Disturbance

Environmental

Product Liability

Commodity Basis / Price

Foreign Exchange

Product Performance

Competition

Head Office Catastrophe

Quebec Separates from Canada

Consumer Preferences

Industrial Espionage

R&D Ventures

Contractual no-Performance

Intellectual Property

Regulatory (CWB, Transportation)

Credit / Receivables

Interest Rates

Stock Market Crash

Counterparty

Inventory

Strategic Planning

Directors & Officers Exposure

Labor Strike

Technology (Choice, Use of )

Data Accuracy

Leverage (Too Much or Too Little)

Transportation

Disease / Spoilage

Loss of Key Personnel

Unionization

Computer System Failure

Mergers and Acquisition

Weather

Employee Injury

Major property exposure

Willis Group Assessment

All-Wheat Yield in Saskatchewan and the July Precipitation for 1960 through 1992

The modeled yield, in turn, explained approximately 94% of variability of UGG’s grain handling earning. The yield depends on the rain according to the regression equation: Yield = 15.5 + 0.0577 * Rain R-squared = 43%

Comprehensive Holistic All Risk Mode (CHARM) CHARM plot showing the probability distribution of earning with and without the impact of the weather. When the weather risk is removed, the variation in EBIT is smaller, as shown by the lighter curve, though expected value is the same. The probability showing incurring a loss as a function of the size of the dollar loss

What is value at Risk (VaR)? • Statistical technique used to measure quantify the level of financial risk within a firm or investment portfolio over a specific time frame. • VaR Component: • A timeframe • A confidence level • A loss amount

• Methods of Calculating VaR: • Historical Method • Variance Method • Monte Carlo Method

Earning at Risk (EAR) • Measures the quantity by which net income might change in the event of an adverse change in interest rates. • VAR looks at change value, EAR looks at potential change in cash flows • Can help answer hedge decision. • Focus on market moves • FX Rates • Interest Rates • Commodity Prices

The Estimation of the 6 Major Risks Risk

Definition

Earning s At Risk

Method to Manage Risk

Weather

Impact on harvested yield

11.5

None

Environmental Liability

Handling of Toxic Waste

2.5

Insurance/control

Counterparty

Failure of Supplier

4.3

Diversification/due diligence/contracts

Credit

Failure of Payment

1.6

Diversification/due diligence/contracts

Inventory

Spoilage of inventory

2.2

Operational Control, Insurance

Commodity

Fluctuation of Price

11.9

Futures and options

The Top 6 Risk Based on Its Severe Risk

Risk Mitigation

Traditional methods

How about weather? It can not be avoided Not effectively be mitigated

New product and service to redu What is the alternate ?

Retention Continue operating as usual and not try to reduce the weather exposure Advantage

Disadvantage

No cost shifting

Higher interest rate because of high risk

Eliminating the risk weather did not guarantee the market value increase

Unexpected low cash flow UGG had to create new product and service to maintain stability cash flow

Weather Derivative A risk management strategy to reduce risk associated with adverse or unexpected weather conditions •The variable to determine the payof Failing rains during the growing period

HDD

Excessiv e rain during harvesti ng Heating degree day option

CDD

High winds in case of plantatio ns  Cooling degree day option

Illustration to Weather Derivative

The gross profit and weather are in linear position. If the index increased the profit increased

With derivative contract, UGG will get hedge when the index is low

The summary from payof and expected profit. The profit from the derivative will be higher when the index is lower

The Insurance Contract Idea • Insurance contract that would pay UGG when the shipments is low • Using the industry-wide grain shipments as the variable to trigger the payment to UGG • With integrating grain volume coverage with UGG’s other insurance coverage. Such as contract that bundle UGG’s existing risk • UGG could limit the potential of grain volume grain loss

Suggestion and Conclusion • UGG has identify the risks that occur to happen in its industry. • There are 6 major risk (Weather, Environment, Counterparty, Credit, Inventory, Commodity) • All the risks can be mitigated except weather. Its hard to managed • To mitigate those risks, we suggest UGG need to use the weather derivative and insurance contract. This will reduce risk exposure and protect company’s cash flow. Although UGG need to pay the cost, but company will be safe from the risk that will cost a great loss to the company