Risk Management Risk Management Outline:

Risk Management

Risk Management
Outline:
Introduction
Definition
Sources of Risk
Frequency, Magnitude, and rating risks
Risk Tolerance
Strategies for Managing Risk
Payoff Matrix
Risk Rules of Thumb

Risk Management

Risk Management
Do You Take Unnecessary Risks????

Risk Management

Risk Management Introduction: Identification and Management of the Sources of Risk (Often attributed to other Reasons) Ignoring Risk Management »» »» Financial Failure Financial Success

Introduction Typical Yield Estimate: Realistic Yield Estimate: Based on historic yields - Last 7 to 12 years disregarding highs and lows and averaging the rest Yield Projections
Yield Projections are strongly influenced by:
Remembering past Good years while forgetting the Bad ones
Optimism on good prices
Projections that are: Honest + Realistic + Representative + Includes Safety Factor = RISK MANAGEMENT Risk Management Usually overestimated by 10 to 20%

Planning so that all your decisions produce a positive impact on your profitability and long-term growth. What is Risk Management? Introduction Risk Management

Risks: “ Measurable possibility of losing or not gaining value” “ Probability of an unfavorable outcome” “ Possibility of events that can jeopardize the fulfillment of GOALS” Risk – Return Trade-off: Higher RISK »» Higher Returns & Vice Versa Definition Risk Management

Sources of Risk: Difficult. Anticipation to changes. Crystal ball? Macroeconomic Difficult. Agribusiness affected by gov. decisions. Institutional Liability insurance Legal Difficult on family (commitment) and external. People Balance between early and late adoption. Technology Difficult due to variability of interest rates. Bank committed to agribusiness. Borrowed capital price Forward contracts. Input price Forward contracts, crop insurance, hedging. Commodity price Crop varieties, right chemicals. Input performance Difficult; high-end products; diversification, rotat. Production (weather, diseases) MITIGATION RISK Risk Management

It may be estimated that once in a generation, every 25 to 35 years, there is a drought that cuts corn yields to 20 bu./acre
Taking the drought yield, 20 bu./acre, and dividing it by the anticipated yield 125 bu./acre = 16% (drought year yield is 16% of expected harvest)
Therefore, the drought caused a yield loss of 84% (100% - 16%)
Frequency, Magnitude, and Rating Risks Risk Management FREQUENCY MAGNITUDE

Now farmer has the data to make a decision like to buy yield insurance.
Risk rating represent standard measures of risk which simplify the process of evaluating alternatives. It’s a consistent, standardized system for considering trade-offs between risks and profits
It is a MUST to develop expected outcomes of yields, costs, & profits
If you can’t MEASURE it, you can’t MANAGE it !!!!
Frequency, Magnitude, and Rating Risks Risk Management

WHAT If’s? Expected outcomes are not sufficient for effective decision making
Weather less favorable
Prices lower than expected
Less production due to genetic variability
More insects than anticipated
Change in government policies
YOU NAME IT!!
Realized returns will not be equal to expected revenues Frequency, Magnitude, and Rating Risks Risk Management

There is always a chance that the outcome of a decision will be less favorable than expected when the decision was made Manager’s responsibility to decide which Risks are MORE critical PROBABILITIES: Concept used in measuring or quantifying chances 50/50 = 1 out of 2 or 0.5 or ½ 25% = 1 out of 4 or 0.25 or ¼ Frequency, Magnitude, and Rating Risks Risk Management

Probabilities: Averages and weighted averages: Frequency, Magnitude, and Rating Risks Risk Management

There are as many degrees of risk tolerance as there are individuals
Based on perception
Different ways on how people respond to risk: Risk averse, neutral or seeker
The above is defined by a variety of factors: specific to the individual, associated with potential gains and losses, manager’s financial position, goals and objectives, etc.
Higher RISK »» Higher RETURNS and Vice Versa Risk – Return Trade-off: Risk Tolerance Risk Management

Risk-bearing ability:
Measures whether the farm operation can withstand financial losses without going into liquidation or insolvency
Risks affecting farm operation lead to Financial Risk (Which is also influenced by proportion of debt and equity)
A Balance Sheet is used to measure the risk-bearing ability of a farm business . ( It summarizes assets, liabilities and the equity of the business)
Ratios used in analysis of risk bearing ability: debt to asset, debt to equity, etc. ( The lower these ratios, the higher risk-bearing ability of the business)
Risk Tolerance Risk Management

Evaluating the Financial Ability to take Risk:
Example with 3 farm situations
They look pretty similar although difference lies in how the farm resources are controlled and financed
The financial position of the farm depends on its net worth and the relationship between this net worth and the total debt outstanding
Risk Tolerance Risk Management

Production / Financial:
Diversification
Enterprise selection
Production management schemes
(cash rent vs. share rent)
Insurance
Farmer’s knowledge base and data base
Availability of outside information
Resource reserves
Government programs
Farmer’s managerial expertise
Marketing / Purchasing:
Several pricing strategies that help establish prices before delivery, such as:
sell cash, storage, forward cash contract, minimum price contract, basis contract,
futures contract, price insurance through “put” options.
They need to be revised on a yearly basis.
Also for purchasing inputs, like forward purchases to lock-in price.
Financial and Personal:
Credit reserves and good liquidity
Pay out ag loans with ag income
Strategies for Managing Risk Risk Management

Sensitivity Analysis:
Another approach to risk assessment
Provides information about a range of possible outcomes
Enables managers to determine which assumptions most strongly affect the forecast and which are secondary
Strategies for Managing Risk Risk Management

Sensitivity Analysis: Making all other variables constant Strategies for Managing Risk Risk Management While making a change in a variable we wish to examine

Technique used to help with decision-making To build it , chart the decision choices against possible events We are concerned about the uncertainty of rainfall We multiply each yield by the net selling crop price: $3 / bu. Payoff Matrix Risk Management

Since we are interested in net payoffs, we subtract fertilizer costs @ 0.2 per unit. 20 units x 0.2 = $4 Now, using probabilities, the expected payoff can be calculated. The expected payoffs are the average return the farmer would expect from each decision choice. ($74 x 30%)+($116 x 50%) +($134 x 20%) = $107 Payoff Matrix Risk Management

Risk Management includes evaluating objectives and using common Sense
What you want to do?
What are reasonable alternatives to evaluate?
Do the best you can to get it done
Risk Rules of Thumb Risk Management Risk Management is more than a method for decision making

Rule #1 ” There are no certain profits” Profits are a return to risk Objective is not to avoid risk, but to manage it Rule #2 “Higher profits are generally associated with higher risks of loss” There are no “slam dunk” investments Hidden risks maybe present Normally, to obtain high profits, you must risk higher losses Rule #3 “There is no one BEST STRATEGY” All strategies are different They vary with manager’s experience and its goals Rule #4 “G ood strategies improve the odds for success” A well thought out plan with good strategies cannot guarantee a good outcome Good strategies will increase the odds of favorable outcomes Risk Rules of Thumb Risk Management

Rule #5 “Decisions should be evaluated with respect to objectives.” To make a decision, gather and compile all data to make it more understandable, then, compare potential results with your objectives Rule #6 “Good decisions sometimes have bad outcomes.” Don’t blame yourself for a bad outcome. It will only distract you from reviewing why it was a bad decision. Learn from mistakes Rule #7 “Good strategies, over time, will produce good results.” Be patient with bad outcomes Risk Rules of Thumb Risk Management

“ If your life is ever going to get better, you’ll have to take risks. There is simply no way you can grow without taking chances.” - David Viscot . “ Take risks: if you win, you will be happy; if you lose, you will be wise.” - Anon . “ Courage is rarely reckless or foolish…..courage usually involves a highly realistic estimate of the odds that must be faced.” - Margaret Truman . “ The only things you regret are the things that you don’t do.” - Michael Curtiz . Quotations about Risk Risk Management

Risk Management Risk Management Outline:

by Micheal22 on Apr 21, 2010

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Risk Management Risk Management Outline: — Presentation Transcript