Disk(s) under separate cover

March 1986

Circular 684

Grain Marketing Strategy Program
For the IBM Personal Computer

'~1~

Steve Smiley and Dick Levins

JAN 30 1990
University of Florida

101 perative Extension Service / Institute of Food and Agricultural Sciences / University of Florida / John T. Woeste, Dean
F636C
684
guide

COMPUTER SERIES] -
Library

Trade names are used liberally in this document. Their mention is for
illustrative purposes only and does not reflect any preference, support,
or relationship by or to the authors, The University of Florida, and The
Cooperative Extension Service, in any explicit or implicit manner.

GRAIN MARKETING STRATEGY PROGRAM
For the IBM Personal Computer

Steve Smiley and Dick Levins

(C), IFAS, University of Florida, 1985

Food and Resource Economics Department
Institute of Food and Agricultural Sciences
University of Florida

ABSTRACT

This manual explains the use of the Grain Marketing Strategy
Program, a microcomputer program designed to analyze different
combinations of hedging, forward contracting and cash sales. The
manual assumes the reader already has a knowledge of futures
trading.

Key words: Hedging, Futures Market, Forward Contracting,
Microcomputers

ACKNOWLEGEMENTS

The authors would like to thank Steve Peterson for his
programming contribution and Susan Phillips for her help on the
documentation. The authors would also like to thank Dr. Ron Ward
and Dr. Dori Comer for reviewing this manual and Dr. Jim Pheasant
for reviewing the software.

GRAIN MARKETING STRATEGY PROGRAM
For the IBM Personal Computer.

Steve Smiley, Dick Levins *

INTRODUCTION

Forward contracting and hedging in the futures market are
marketing tools which farmers can selectively use to reduce their
price risks thus adding greater stability to their returns and the
overall farm operation. A considerable amount of time and effort,
however, are needed to determine if a given futures strategy is
potentially profitable.

The Grain Marketing Strategy Program developed for the IBM
Personal Computer performs the calculations needed to analyze
various marketing strategies quickly and accurately. The program
gives the farmer the opportunity to compare expected income from
different combinations of hedging, forward contracting and cash
sales.

COMPARING MARKETING ALTERNATIVES

Producers selling in the cash market are paid the current
cash price at the time of sale. Producers with similar quality
product receive about the same price regardless of the price level.

A real disadvantage of trading only in the cash market is
that farmers produce for an unknown cash price and therefore bear
the full risk of adverse price fluctuations. If prices move
drastically lower at harvest time, the producer must either accept
the low price or make arrangements for storage. If prices move
higher, of course, the producer may realize a large profit. Another
disadvantage of using the cash market is the difficulty producers
have in making production decisions several months before the
selling price is known.

Forward contracting with a buyer prior to harvest also has
desirable and undesirable properties. Knowing the price that will
be received before the product is harvested is the primary benefit

-------------------------
* Former Graduate Research Assistant and Former Extension Farm Management Specialist, Food and Resource Economics Department,
Institute of Food and Agricultural Sciences, University of Florida, Gainesville.

of forward contracting for the producer since better production and
harvesting planning decisions can be made. Like the cash market,
forward contracting requires no margin money. Unlike the
futures market, forward contracts are not for specific standard
sizes. Instead, the contract size is negotiated between buyers and
sellers.

A major disadvantage of using forward contracts is reduced
selling flexibility. For example, if a grain producer contracts to
deliver grain at harvest, the option of storing beyond the contrac-
ting period in hopes of achieving higher prices is lost. Forward
contracting also means that the buyer takes some risk in setting an
exact price, so the offering price may be discounted to offset this
risk. In addition, the producer must deliver at the price set in
the forward contract even if the cash price at harvest time is much
higher.

In the futures market, as in forward contracting, the price
is established before delivery or closing period of the contract.
The producer can better evaluate the profit potential of production
decisions while the crop is being grown.. The futures market also
provides maximum market flexibility because a buyer or seller can
terminate the market position at any time. In this way, the
producer can cut losses and take profits as opportunities arise.
Another advantage of the futures market is that prices are set in a
competitive market with many buyers and sellers. In some markets
there is limited competition as with cash markets and forward
contracting.

Relatively few farmers use the futures market because it is
considerably more complex to use than the cash market. To hedge
effectively in the futures market requires knowledge of how the
market works, a good broker and a well-designed trading plan.
Margin money or "good faith" money insures performance on the
futures commitment and is required in futures trading. One
difficulty some producers may have using the futures market is that
futures contracts are often defined in commodity units that do not
correspond to the producer's needs.

The difference between the futures price and today's local
cash price is called the "basis". Supply and demand, transportation
costs, storage space, and quality factors all influence the basis.
Knowledge of the normal seasonal basis relationship is essential to
effectively using futures markets to improve marketing decisions.
As a general rule producers benefit from a narrowing of the basis
from the point when the contract was established until termination.
Likewise, a widening of the basis always works to the disadvantage
of the producer. This is true since producers would only establish
short hedged positions.

SYSTEM SPECIFICATIONS AND GETTING STARTED

The Grain Marketing Strategy Program runs under MS-DOS using
IBM BASICA and requires 64K and one disk drive. A printer is
optional to receive hardcopy output.

The distribution disk contains only the Grain Marketing
Strategy Program. Therefore, the user may want to copy the program
(file name HEDGER.BAS) to a system disk containing the file
BASICA.COM. To start the program type BASICA, then at the OK prompt
type RUN"HEDGER.BAS". More advanced users may want to create an
autoexec file for automatic loading and running.

THE GRAIN MARKETING PROGRAM

The basis, forward contract prices, and futures market prices
are always changing. Farmers must therefore continually recalculate
the profitability of different pricing alternatives. This tedious
process can be greatly simplified by using the Grain Marketing
Strategy Program. In a few seconds the program calculates the
profitability of any combination of marketing strategies. The
calculations can be repeated as often as desired.

The program first asks for the information necessary to carry
out the analysis. The production cost, in dollars per acre,
includes all planting, growing, harvesting costs, and the cost of
transporting the product to the cash market. The current forward
contract price is normally obtained from the local elevator. The
brokerage fee for a complete round-turn on a futures contract and
the current futures price is available from a commodities broker.
The expected closing basis at harvest time is the producer's best
estimate based on current conditions and past trends.
Think carefully before entering the expected cash price at
harvest. The computer calculates the profitability of different
marketing alternatives using a range of cash prices based on the
estimate entered by the user. It is wise to re-run the program
several times using different expected cash prices at harvest.

The computer will also ask for the number of acres planted in
the specific crop and the expected yield per acre. An accurate
estimate of the expected yield per acre is crucial to the outcome,
even though the program will use a range of expected yields when
calculating the sensitivity analysis.

The last input that the user enters is an increment size for
use in the sensitivity analysis. The computer will calculate the
returns over production costs based on a range of expected closing
cash prices. The increment size will determine the range. For
example, the user may want to see results as the closing cash price
varies by $0.01. The user may enter any appropriate value but if no
value is entered the program will automatically use an increment
size of $0.01.

Now the user has the opportunity to determine the most
profitable combination of marketing outlets. The computer displays
the number of bushels the user can expect to harvest based on the
number of acres planted and the expected yield. This amount is the
maximum number of bushels which the producer may hedge in the
futures market without being a speculator. At this point in the
program the user may choose to hedge or forward contract for any
number of bushels. Any bushels not hedged or forward contracted are
assumed to be sold in the cash market. The user may also choose to
sell everything in one of the three markets. Before the program
calculates the results the user is given a chance to change any of
the input values.

To see the results press when prompted and the program will
display the total production cost, current futures price, basis,
forward contract price, total expected yield, bushels hedged and
bushels contracted and bushels sold at harvest as previously entered
by the user. A table is displayed showing a sensitivity analysis of
the returns over production cost based on the selected strategy.
The table also shows the returns over production cost for 100% cash
sale at harvest.

The sensitivity analysis is completed on three possible yields
and seven different cash prices. The middle price is the expected
closing cash price entered by the user and the middle yield is the
expected yield per acre entered by the user.

At this point in the program the user is given the chance to
print the analysis. It is a good idea to get a hard copy output for
later referral and comparisons among other marketing or pricing
strategies. If a response is given the user is next able to
change prices, yield estimates and the marketing strategy for the
same crop. This allows for easy creation of "what if" scenerios.
The user is wise to re-run the program using a different expected
closing basis, since the basis is rarely exactly as predicted.

To evaluate a marketing strategy for a new crop simply end the
program when prompted and then type "RUN". This will cancel all
previous entries and restart the program.

A SAMPLE RUN

Here is what the display looks like on a sample run. The
numbers are used here as examples and are not provided by the
computer.

In this example, the grower can produce soybeans at a breakeven
cost of $150 per acre. The current futures price is $5.75 per
bushel. The grower expects the basis at harvest to be $0.35 per
bushel and expects the cash price at harvest to be $5.25 per bushel.
The broker charges $0.01 per bushel for a complete round-turn on a

futures contract and the current forward contract price is $5.50 per
bushel. Five hundred acres of beans are planted and the expected
yield is 30 bushels per acre.
In the bottom part of the screen the user chooses a marketing
strategy. In this example, the producer expects to harvest 15,000
bushels of soybeans. The strategy to be evaluated is that of
hedging 5000 bushels in the futures market, contracting to sell 5000
bushels at the current forward contract price and selling 5000
bushels in the cash market. At the end of the season the producer
offsets the futures market position with sales in the cash market.
The program assumes the futures contract positions are offset on the
same day the grain is sold in the cash market and at the same price.

NAME OF CROP : ? SOYBEANS

1) TOTAL PRODUCTION COST ($/ACRE) $150.00
2) CURRENT FUTURES PRICE($/BU) $ 5.75
3) EXPECTED CLOSING BASIS ($/BU) $ 0.35
4) BROKERAGE FEE ($/BU) $ 0.01
5) CURRENT FORWARD CONTRACT PRICE ($/BU) $ 5.50
6) EXPECTED CASH PRICE AT HARVEST ($/BU) $ 5.25
7) NUMBER OF ACRES PLANTED 500
8) EXPECTED YIELD (BU/ACRE) 30
9) INCREMENT FOR SENSITIVITY ANALYSIS $ 0.15

M) MARKET STRATEGY YOU EXPECT TO HARVEST 15000 BUSHELS
HOW MANY BUSHELS WILL YOU HEDGE ? 5000
HOW MANY BUSHELS WILL YOU FORWARD CONTRACT ? 5000
BUSHELS TO SELL AT HARVEST 5000
CHANGE WHICH ITEM (1-9, or M), S TO SEE RESULTS, Q TO QUIT PROGRAM:

The computer now re-displays the input numbers and displays the
sensitivity table:

.GRAIN MARKETING STRATEGY PROGRAM -- UNIVERSITY OF FLORIDA

PRODUCTION COST ($/ACRE) 150.00 TOTAL EXPECTED YIELD (BU) 15000
CURRENT FUTURES PRICE ($/BU) 5.75 BUSHELS HEDGED 5000
EXPECTED CLOSING BASIS ($/BU) .35 BUSHELS CONTRACTED 5000
FORWARD CONTRACT PRICE($/BU) 5.50 BUSHELS SOLD AT HARVEST 5000
RETURNS OVER PRODUCTION COST FOR SOYBEANS

EXPECTED 25 BU/ACRE 30 BU/ACRE 35/BU ACRE
CASH
PRICE AT SELECTED 100% SELECTED 100% SELECTED 100%
HARVEST STRATEGY CASH STRATEGY CASH STRATEGY CASH
4.80 $-8550 $-15000 $ 3450 $-3000 $ 15450 $ 9000
4.95 $-8175 $-13126 $ 4200 $-750 $ 16575 $ 11625
5.10 $-7800 $-11250 $ 4950 $ 1500 $ 17700 $ 14250
5.25 $-7425 $-9375 $ 5700 $ 3750 $ 18825 $ 16875
5.40 $-7050 $-7500 $ 6450 $ 6000 $ 19950 $ 19500
5.55 $-6675 $-5625 $ 7200 $ 8250 $ 21075 $ 22125
5.70 $-6300 $-3750 $ 7950 $ 10500 $ 22200 $ 24750

DO YOU WANT THIS REPORT PRINTED Y/N

In the ranges estimated by the computer, the smallest gain
(largest loss) over the production cost is $-15,000 for a 100% cash
sale at harvest and occurs when yield is low and the expected cash
price at harvest is low. The largest gain, $24,750 is realized at
a high price and high yield for a 100% cash sale at harvest. Not
every possible outcome yields a profit with this particular strategy
as evidenced by the negative signs in the output table shown above.

The table also shows the returns over production costs for
100% cash sale at harvest. This allows the user to compare the
selected strategy to selling in the cash market only. For example,
if the expected cash price at harvest had risen beyond the futures
price the results would have indicated that a 100% cash sale at
harvest would have been a better decision.
By re-running the program a number of times with different
combinations of hedging, forward contracting, and cash sales, a
marketing strategy which is acceptable from both income and risk
perspectives can be determined. The program should also be run
with a number of different values for the expected basis and cash
price at harvest since these values are rarely known with
certainty.

II IIiH1 fllll iiM1l llll
3 1262 04411325 7
The microcomputer greatly reduces the amount of time required
to perform the calculations necessary for evaluating a number of
different marketing and price strategies. However, the usefulness
of the program is in large part dependent on the predictive power
of the cost, yield and price estimates and the closing basis.

ORDERING INFORMATION
For information on this and other IFAS software contact your
county extension office or write to:

IFAS Software Communication and Distribution
G022 McCarty Hall
University of Florida
Gainesville, FL 32611

/ <- ~-;~( .~

LIBRARCE
LIBRARY

This publication was produced at a cost of $175.88, or 93 cents per copy, to provide information on a grain marketing
strategy program for the IBM personal computer. 3-190-86

COOPERATIVE EXTENSION SERVICE, UNIVERSITY OF FLORIDA, INSTITUTE OF FOOD AND AGRICULTURAL
SCIENCES, K. R. Tefertiller, director, in cooperation with the United States Department of Agriculture, publishes this infor-
mation to further the purpose of the May 8 and June 30, 1914 Acts of Congress; and Is authorized to provide research, educa-
tional Information and other services only to Individuals and Institutions that function without regard to race, color, sex or
national origin. Single copies of Extension publications (excluding 4-H and Youth publications) are available free to Florida
residents from County Extension Offices. Information on bulk rates or copies for out-of-state purchasers Is available from
C. M. Hinton, Publications Distribution Center, IFAS Building 664, University of Florida, Gainesville, Florida 32611. Before publicizing this
publication, editors should contact this address to determine availability.