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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
UGGs
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
Arisk 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 UGGs other insurance
coverage. Such as contract that bundle UGGs 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 companys cash flow. Although UGG need to pay the
premium cost, but company will be safe from the risk that will cost a
great loss to the company