United Grain Growers

Limited (A)

Syndicate 5 (Ape Syndicate)
Yuliana Irmina 29110389
Decky Prasakti 29110391
Resti Athayani 29110402
Ronaldo Bagus Putra
29110404
Lamya Nur Zahidah 29110406
Harry Riusxander 29110408
Wisnumurti Rahardjo 29110412

Background
• United Grain Growers (UGG) is one of the Canada
oldest grain distributors in Canada.
• The agriculture business was risky. Anything that
affected the quantity of grain shipped had a
material impact on the firm’s revenues, profits and
cash flow.
• UGG was still faced with the problem of how to
deal with the biggest risk: the weather
• UGG has to identify the principal risks of the
corporation’s business and ensuring the
implementation of appropriate systems to manage
these risks.

Grain
Distribution

Agriculture and in
particular industry
was one of
civilization’s oldest
industries
The industry is quite
volatile, characterizes
by boom and bust
cycles, and its roots in
the forces of supply
and demand in the
global market

Grain supplies were
variable due to
natural forces such
as pests, disease
and weather.

many countries create policies in Canada for wheat (barley and oats/board gain) regulated by Canadian Wheat Board (CWB) that mandated monopsony Grain distributor like UGG were important intermediateries between the farmer and the end market.To reduce volatility. Three largest distributor in 1998 were Saskatchew an Wheat Pool. and UGG . Agricore.

The Canadian agriculture industry was under pressure from several directions. In 1995. and many farmers disagreed with CWB policies and its monopsony power. goverment repealed legislation that kept gain transportation cost fixed (and low) for many years. . and reviewing other grain transpotation and distribution systems.

upgrade existing elevator.Since 1993. derive about 70% of its income from grain operation United Grain Growers Established in 1906 UGG spent about $65 million on acquiring and building its nongrain handling business Build new HTP elevators. funding activities Initial Public Offering Core Division .

Higher grain prices .Four out of the five major competitors lost money in the handling business .The Industry Climate 1955 .UGG had to take $12.Distributors can set their own tariffs .Poor harvest contribution .New Industry regulation .Railroads began consolidating routes .5 million charge to close 93 country elevators .

the bidders withdrew their offer Two bidders merged from Agricore .The Industry Climate Alberta Pool Takeover UGG Manitoba Pool Elevators Rather than suffer substantial dilution of their existing investment.

and increase market shares • UGG also formalized a partnership with Marubeni Corporation .The Industry Climate • UGG formed a strategic alliance with Archer Daniels Midland Company ADM would gain “a secure grain supply for its processing operations” UGG could “plan more efficiently for future transportation and grain handling demands.

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 .

1997. to rank them. with task : 1.On site Risk Brainstorming February 11. by polling the group. twenty UGG senior managers and other employees met for an on site risk brainstorming. to identify the risk the firm faced 2. in relative importance to the firm .

commodity price risk B. customer and supplier counterparts risk D. account receivable and credit risk E. weather risk . inventory management risk C.Willis Attention Willis focused its attention on the first group of six which included : A. environmental risk F.

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

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 .CHARM CHARM (Comprehensive Holistic All Risk Model) generated graphical output in several formats to highlight the various aspect of each risk. 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 .

• But about the weather risk ? – No financial products that would effectively mitigate the weather risk – Innovation to mitigate : weather derivatives  pay a specified amount of money as a function of a particular weather characteristic .What to do about the weather ? • Five of the six risk could be managed through traditional methods.

6 Diversification/Due diligence/Contract Inventory Spoilage of Inventory. UnderStock/OverSt ock 2. and Insurance Commodity Price Fluctuation 11.5 Insurance and control Counterpart y Failure of Supplier 4.2 Operational Control.5 Weather Derivatives and Insurance Environment Toxic waste 2.9 Futures and Options .Six Major Risk Risk Instance(s) Earning at Risk Possible Alternatives Weather Impact on harvested yields 11.3 Diversification/Due diligence/Contract Credit Payment Failure 1.

.

transportation) Credit/receivables Counterparty Directors & officers exposure Data accuracy Disease/spoilage Computer system Inventory Labor strike Leverage (too much or too little) Loss of key personnel Mergers and acquisition Stock market crash Strategic planning Technology (choice. use of) transportation unionization .List of Risk Business interruption Employee liability Cargo/marine exposure Employee performance /fidelity Civil disturbance environmental Process compliance/execution Commodity basis/ price Foreign exchange Product liability Head office catastrophe Product performance Competition Pension plan performance Consumer preferences Industrial espionage Quebec separates from Canada Intellectual property R&D ventures Contractual noperformance Interest rates Regulatory (CWB.

Willis Group Assessment 1 Weather 2 Environment Liability 41 Risks The Major Risks are 3 Counterparty 4 Credit 5 Inventory 6 Commodity .

The yield depends on the rain according to the regression equation Yield=15.heat yield in Saskatchewan and the July precipitation for 1960 through 1992 The modeled yields. .0577*Rain. in turn.5+0. R-squared = 43%. explained approximately 94% of the variability of UGG’s grain handling earning.

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

• Captures diversification or Portfolio Effect. Identifies ‘How Much’ one can loses if adverse market conditions prevail. • Measurisk Approach – Full Monte-Carlo Valuation-based without approximations – Risk calculation based on evaluation of log changes in market instruments – Method allows modeling of entire distribution of expected profits and losses and shape of risk surface over time and tail risk Nasdaq Drop Asian Flu Drop Nasdaq 95% VaR Euro Rally .Definition: What is Value at Risk? • • Summary statistic that quantifies the exposure across many assets/liabilities classes to market risk.

e. Each quarter of the fiscal year) • Quantify risk across business lines • Ability to optimize trading activities view impact of different hedging strategies .Earnings at Risk and Corporate Treasury • Longer time horizon than traditional asset management • Multi-Step Monte Carlo • More data needed to define covariance matrix • View of multiple time horizons (I.

Earnings at Risk • • • • • Measure of earnings volatility Income Statement Perspective Used to define risk appetite Can help answer “What should be hedged?” Focus on market moves to: – FX Rates – Interest Rates – Commodity Prices • Perspective: Basket of Exposures Effect”) (“Portfolio .

5 None Toxic waste 2. UnderStock/OverSto ck 2.6 Diversivicaiton/DD/ Contract Inventory Spoilage of Inventory.The Estimation of the 6 Major Risks Risk Instance(s) Earning at Risk Possible Alternatives Weather Impact on harvested yields 11.5 Insurance Counterparty Faliure of Supplier 4.9 Insurance/ Futures Environtment Liability .2 Operational Control Commodity Price Fluctuation 11.3 Diversivicaiton/DD/ Contract Credit Payment Failure 1.

Commodity . Weather 4.The top 6 Risk based on its severe risk 1.

1 Weather Risk Exposure ALTERNATIVE RISK MANAGEMENT APPROACHES Retentio n Weather Derivatives The Insurance Contract Idea .

Retention • First.going services to customers . although much of UGG’s current business could be characterized as a commodity business. the variability in its cash flows caused UGG to hold extra equity capital as a cushion against unexpected low cash flows in any given year. • Second. UGG had been and planned to continue making large investments in storage facilities (grain elevators). • Third. UGG tried to distinguish itself from competitors by creating products 7 with brand names and by providing on.

.Weather Derivatives • Weather derivatives were a relatively new risk management tool. Although Willis had performed a sophisticated analysis of the effect of weather on UGG’s gross profit. • Hedging their weather risk with derivatives was feasible. • For simplicity. • A contract could be tailored on a number of dimensions to meet the specific needs of the buyer. but it suffered from several difficulties. a derivative contract that would pay UGG money when the index is low would provide a hedge. Since low values of the weather index correspond to low expected profits for UGG. the illustration assumes that the relationship between gross profit and the weather index is linear. the results of this analysis had to be converted into a desired contract structure.

Illustration of a Weather Derivative .

• One solution to this problem was to use industry-wide grain shipments as the variable that would trigger payments to UGG. • The obvious problem with such a contract is the moral hazard problem – UGG’s pricing and service also influences its grain shipments. . including a division of the large reinsurer Swiss Re. Located in New York. • UGG also considered the possibility of integrating grain volume coverage with UGG’s other insurance co • Willis then contacted several major commercial insurers. this group structured innovative risk financing deals for commercial entities.The Insurance Contract Idea • UGG knew that the primary reason weather was important was because weather affected UGG’s grain shipments. called Swiss Re New Markets.

EBIT Changes in weather was ranked the highest source of risk Grain volume and lagged crop yields highly positively correlated Relationship between weather and gross profit Weather >>> Crop Yields >>>> Grain Volume >>>> Gross Profit . EVA.Risk Assessment to the weather problem Estimate probability distribution of and correlation among losses Measure the expected loss individually and in combination on ROE.

Insurance Counterpart Diversivication of parnership to avoid depedency with limited number of partners . Conterparty and Inventory Risk Exposure 2 Environment Liabilities -Insurance .Options 5 6 Credit Inventory -Increase Control . Credit.Be more selective to choose partner - .Environment Liabilities. Commodity.Increase Control 3 4 Commodity Diversivication of parnership to avoid depedency with limited number of partners .Be more selective to choose partner - -Futures .

The premium of insurance cost can be reduced 3. Broader Loss Coverage.Suggestion and Conclusion We propose the use of insurance for the weather uncertainty (option 3) due : 1. not only weather risk 2. Company would much more safe .