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Hedging Cash Flows from Commodity Processing

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  • Dahlgran, Roger A.

Abstract

Agribusinesses make long-term plant-investment decisions based on discounted cash flow. It is therefore incongruous for an agribusiness firm to use cash flow as a plant-investment criterion and then to completely discard cash flow in favor of batch profits as an operating objective. This paper assumes that cash flow and its stability is important to commodity processors and examines methods for hedging cash flows under continuous processing. Its objectives are (a) to determine how standard hedging models should be modified to hedge cash flows, (b) to outline the differences between cash flow hedging and profit hedging, and (c) to determine the effectiveness of hedging in reducing cash flow variability. A cash flow hedging methodology is developed. This methodology is similar to that used for batch profit hedging. This methodology balances the daily cash flow destabilizing effect of futures positions against the periodic cash flow destabilizing effect of cash price changes. The resulting cash flow hedges are simulated for soybean processors. These hedges are less effective than batch profit hedging. The reduction in cash flow variance achieved through hedging, though small, is nonetheless statistically significant.

Suggested Citation

  • Dahlgran, Roger A., 2005. "Hedging Cash Flows from Commodity Processing," 2005 Conference, April 18-19, 2005, St. Louis, Missouri 19046, NCR-134 Conference on Applied Commodity Price Analysis, Forecasting, and Market Risk Management.
  • Handle: RePEc:ags:ncrfiv:19046
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    File URL: http://purl.umn.edu/19046
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    References listed on IDEAS

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    1. Anderson, Ronald W & Danthine, Jean-Pierre, 1980. " Hedging and Joint Production: Theory and Illustrations," Journal of Finance, American Finance Association, vol. 35(2), pages 487-498, May.
    2. Rahman, Shaikh Mahfuzur & Turner, Steven C. & Costa, Ecio de Farias, 2001. "Cross-Hedging Cottonseed Meal," Journal of Agribusiness, Agricultural Economics Association of Georgia, vol. 19(2).
    3. Purcell, Wayne D. & Riffe, Don A., 1980. "The Impact Of Selected Hedging Strategies On The Cash Flow Position Of Cattle Feeders," Southern Journal of Agricultural Economics, Southern Agricultural Economics Association, vol. 12(01), July.
    4. Myers, Robert J. & Thompson, Stanley R., 1988. "Generalized Optimal Hedge Ratio Estimation," Staff Papers 200967, Michigan State University, Department of Agricultural, Food, and Resource Economics.
    5. Anderson, Ronald W & Danthine, Jean-Pierre, 1981. "Cross Hedging," Journal of Political Economy, University of Chicago Press, vol. 89(6), pages 1182-1196, December.
    6. Purcell, Wayne D. & Riffe, Don A., 1980. "The Impact of Selected Hedging Strategies on the Cash Flow Position of Cattle Feeders," Journal of Agricultural and Applied Economics, Cambridge University Press, vol. 12(01), pages 85-93, July.
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    Keywords

    Agribusiness; Marketing;

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