Name : Zakya

Nim : 2110531034

United grain growers

1. company overview
UGG sells agricultural goods globally and offers business services to farmers from its base in
Winnipeg, Manitoba. It was established in 1906 as a cooperative owned by farmers, and in
1993 it went public by listing on the Toronto and Winnipeg stock markets. Information on the
stock price of UGG since coming public is shown in Figure 1.
Despite being a publicly traded firm, UGG still has some farmer cooperative roots. Members
and stockholders together make up the corporation. The cooperative's members (farmers)
immediately joined the new company at the time of the initial public sale, and they also got
restricted voting common shares (thus making them both members and shareholders of the
new organization). If a person conducts a certain volume of business with the firm but is not
yet a member, they are eligible to apply. Non-members might become shareholders through
the initial public offering and future equity offers.
Members do have control rights, even if they are not eligible to receive a portion of the
company's profits or distributions (unless they are also shareholders). 12 of the 15 directors of
UGG must be "members" chosen by delegates who represent members from diverse
geographical regions.
2. Risk mitigation
Three different plans were available to lessen the danger.
Retention
One strategy was to carry on as normal and avoid making any attempts to lessen their
exposure to the elements. As was previously mentioned, this strategy left their profitability
vulnerable to significant fluctuations brought on by changing weather. This unpredictability
had a number of drawbacks. First, UGG had made significant expenditures in storage
facilities and expected to do so going forward (grain elevators). The business would be able
to avoid the expenses related to soliciting outside capital if it could finance these capital
expenditures with internally produced money. In addition, if the company kept the weather
risk and external capital was required, the interest rate on the borrowed money would
probably be greater. Second, due to the unpredictability of its cash flows, UGG had to keep
back extra equity capital to protect itself from unforeseenly weak cash flows in any given
year. Reduced weather risk would allow the company to finance more of its operations with
debt without having to pay higher yields, giving it access to more interest tax shelters. Third,
despite the fact that a large portion of UGG's present business may be categorized as a
commodity industry, the company made an effort to set itself apart from rivals by developing
items with recognizable brand names and offering ongoing customer services. The company
might better define itself as a business that suppliers and consumers could rely on for service
and high-quality products for many years if its cash flows were stable. Moreover, as the
agricultural goods market adapted to scientific advancements, the significance of supplier and
customer connections was projected to rise in the years to come. Analysts expected that
during the following ten years, food manufacturers will want certain genetically modified
crops, necessitating the planting of particular seeds by farmers. A network of information,
storage facilities, and transportation systems would be necessary to coordinate these
operations between farmers and food producers. UGG considered itself to be a supplier of
these middlemen services. The expense of moving the weather risk to someone else was the
main benefit of keeping it. Furthermore, given that most investors could readily diversify
themselves against weather risk, Mike and Peter were unsure that the capital markets would
reward the company for removing it.
Weather derivatives
Weather derivatives were a relatively new risk management technique in the late 1990s.
Companies like Enron marketed these contracts in the over-the-counter (OTC) market. To fit
the particular requirements of the customer, a contract might be customized along a variety of
axes. For instance, one or a combination of meteorological factors, such as average
temperature, rainfall, snowfall, a heat index, or the number of heating or cooling degree days,
might be the underlying variable influencing the payoffs. A put option, a call option, a swap,
or a mix of these structures might all be examples of the payout structure. An illustration of
how UGG can perhaps make use of a weather derivative is shown in Exhibit 13.
Let's say UGG's anticipated gross profit followed the pattern shown, based on Willis' estimate
of the sensitivity of agricultural yields to weather and the sensitivity of gross profit to crop
yields. The horizontal axis measures a weather index, which is equivalent to a weighted
average of different temperature and precipitation measures in western Canada. The vertical
axis represents predicted gross profit. Because crop yields rise with the index, UGG should
expect higher gross profits as a result of higher grain and seed shipments. The picture makes
the straightforward assumption that there is a linear connection between gross profit and the
weather index. A derivative contract that pays UGG money when the weather index is low
would serve as a hedge since low values of the weather index correlate to low predicted
profits for UGG. Although it was possible, using derivatives to offset their weather risk had a
number of drawbacks. Even though Willis had conducted a thorough research of how the
weather affected UGG's gross profit, the analysis's findings still needed to be transformed
into the ideal contract structure. In other words, it would be necessary to provide the
underlying weather index that determined the derivative contract's payment. The success of
the derivative contract in mitigating UGG's risk would then need to be evaluated. UGG
would then need to get pricing bids in a market with not many competitors.
The Idea of an Insurance Contract
Mike McAndless and Peter Cox came up with a different solution to the firm's weather risk
while discussing the weather study. They were aware that weather was crucial since it had an
impact on the shipments of grain made by UGG.
As a result, they pondered if they might create an insurance agreement that would
compensate UGG when its grain supplies were unusually low. The moral hazard issue with
such a contract is the obvious one. Grain shipments are also influenced by UGG's pricing and
service. Using industry-wide grain shipments as the variable to initiate payments to UGG was
one approach to this issue. According to the likelihood that industry shipments and UGG's
shipments are highly associated, there is little basis risk. UGG would also have little impact
on the value of shipments made by the whole business because to its small market share,
which would considerably lessen the moral hazard issue. Mike and Peter also debated the
idea of combining UGG's existing insurance coverage with grain volume coverage. For
various conventional risk exposures, UGG now offers a variety of insurance policies. They,
for instance, bought a number of insurance policies to cover their property exposures (such as
a boiler and machinery policy to cover losses on machinery and equipment) and liability
insurance to cover their exposure to tort liability (e.g, environmental impairment liability).
Each insurance had a different retention percentage and coverage cap. UGG might substitute
the separate deductibles and limitations with an overall yearly aggregate deductible and limit
that would apply to all or a subset of losses, including grain volume losses, by combining its
numerous coverages under a single policy. Mike gave Willis a call and requested them to
look into the idea of setting up an insurance contract on grain shipments for the business.
Willis then got in touch with a number of significant commercial insurers, including Swiss
Re New Markets, a subsidiary of the large reinsurer Swiss Re. This New York-based
organization designed novel risk financing contracts for business companies.