Hanindita Guritna29114713Hussein Al-Muhtadeebillah29114737Felix Terahadi29114744Rini Amelia29114857Hidratul Fidic D29114859

Background

Grain DistributionVolatileCharacterized by boom and bust cycleVariable supplies due to natural forcesRegulations Created to reduce fluctuations

Grain DistributionIn Canada, Farmers sold Board Grains to the Canadian Wheat Board (CWB) to guarantee a floor priceGrain Distributors like UGG were important intermediaries between the farmers and the end marketFarmers hauled their grain to grain elevators and pays the handling feeUGG Revenues from this service (1999): $19/ tons from regulated and non-regulated grainsThe Big Players: Saskatchewan Wheat Pool (30%), Agricore (25%), and UGG (15%)

United Grain Growers

United Grain Growers (cont.)

The Willis ReportEmerging interest in risk management prompted UGG to participate in a benchmarking review of best risk management practices in its Treasury department1992, shareholders successfully sued their directors because the firm did not hedge it's grain risk when prices were falling

On site Risk Brainstorming

Willis Attention

Earnings at Risk (EaR)Which had been developed by the financial community, to describe aggregate riskEaR expressed a "worst-case" loss, set against a benchmark of expected profit, within a specified confidence or probability level.

CHARMCHARM (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 InterruptionEmployee LiabilityPension Plan PerformanceCargo / Marine ExposureEmployee Performance / FidelityProcess Compliance / ExecutionCivil DisturbanceEnvironmentalProduct LiabilityCommodity Basis / PriceForeign ExchangeProduct PerformanceCompetitionHead Office CatastropheQuebec Separates from CanadaConsumer PreferencesIndustrial EspionageR&D VenturesContractual no-PerformanceIntellectual PropertyRegulatory (CWB, Transportation)Credit / ReceivablesInterest RatesStock Market CrashCounterpartyInventoryStrategic PlanningDirectors & Officers ExposureLabor StrikeTechnology (Choice, Use of )Data AccuracyLeverage (Too Much or Too Little)TransportationDisease / SpoilageLoss of Key PersonnelUnionizationComputer System FailureMergers and AcquisitionWeatherEmployee InjuryMajor property exposure

Willis Group Assessment

All-Wheat Yield in Saskatchewan and the July Precipitation for 1960 through 1992The 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 timeframeA confidence levelA loss amountMethods of Calculating VaR:Historical MethodVariance MethodMonte 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 flowsCan help answer hedge decision.Focus on market moves FX RatesInterest RatesCommodity Prices

The Estimation of the 6 Major Risks

RiskDefinitionEarnings At RiskMethod to Manage RiskWeatherImpact on harvested yield11.5NoneEnvironmental LiabilityHandling of Toxic Waste2.5Insurance/controlCounterpartyFailure of Supplier4.3Diversification/due diligence/contractsCreditFailure of Payment1.6Diversification/due diligence/contractsInventorySpoilage of inventory2.2Operational Control, InsuranceCommodityFluctuation of Price11.9Futures and options

The Top 6 Risk Based on Its Severe Risk

Risk MitigationTraditional methods

How about weather?Not effectively be mitigatedIt can not be avoidedNew product and service to reduce lostWhat is the alternate ?

RetentionContinue operating as usual and not try to reduce the weather exposure

AdvantageDisadvantageNo cost shifting Higher interest rate because of high riskEliminating the risk weather did not guarantee the market value increaseUnexpected low cash flowUGG had to create new product and service to maintain stability cash flow

Weather DerivativeArisk management strategy to reduce risk associated with adverse or unexpected weather conditions

The variable to determine the payoff

High winds in case of plantations

Failing rains during the growing period

Excessive rain during harvesting

Heating degree day option

HDD

CDD

Cooling degree day option

Illustration to Weather DerivativeThe gross profit and weather are in linear position. If the index increased the profit increasedWith derivative contract, UGG will get hedge when the index is lowThe summary from payoff and expected profit. The profit from the derivative will be higher when the index is lower

The Insurance Contract IdeaInsurance contract that would pay UGG when the shipments is lowUsing the industry-wide grain shipments as the variable to trigger the payment to UGGWith integrating grain volume coverage with UGGs other insurance coverage. Such as contract that bundle UGGs existing riskUGG could limit the potential of grain volume grain loss

Suggestion and ConclusionUGG 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 managedTo 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