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 firms 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
corporations business and ensuring the
implementation of appropriate systems to manage
these risks.

Grain
Distribution

Agriculture and in
particular industry
was one of
civilizations 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.

To reduce volatility, 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.

Three
largest
distributor in
1998 were
Saskatchew
an Wheat
Pool,
Agricore,
and UGG

The Canadian
agriculture industry
was under pressure
from several
directions, and
many farmers
disagreed with CWB
policies and its
monopsony power.

In 1995, goverment
repealed legislation
that kept gain
transportation cost
fixed (and low) for
many years, and
reviewing other
grain transpotation
and distribution
systems.

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, upgrade
existing elevator,
funding activities

Initial Public
Offering

Core Division

The Industry
Climate
1955
- New Industry
regulation
- Poor harvest
contribution
- Railroads began consolidating
routes
- Distributors can set their own
tariffs

- Higher grain prices

- Four out of the five major competitors lost money in the
handling business
- UGG had to take $12.5 million charge to close 93 country
elevators

The Industry
Climate
Alberta
Pool

Takeover
UGG

Manitoba
Pool
Elevators

Rather than suffer

substantial dilution of their
existing investment, the
bidders withdrew their
offer
Two bidders merged
from Agricore

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, and increase market shares

UGG also formalized a partnership

with Marubeni Corporation

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

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

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

Earnings at Risk (EaR)

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

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

What to do about the

weather ?
Five of the six risk could be managed
through traditional methods.
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

Six Major Risk

Risk

Instance(s)

Earning at
Risk

Possible
Alternatives

Weather

Impact on
harvested yields

11.5

Weather
Derivatives and
Insurance

Environment

Toxic waste

2.5

Insurance and
control

Counterpart
y

Failure of Supplier

4.3

Diversification/Due
diligence/Contract

Credit

Payment Failure

1.6

Diversification/Due
diligence/Contract

Inventory

Spoilage of
Inventory,
UnderStock/OverSt
ock

2.2

Operational
Control, and
Insurance

Commodity

Price Fluctuation

11.9

Futures and
Options

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,
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

Willis Group Assessment

Weather
2 Environment Liability

41
Risks

The Major
Risks are

Counterparty
4 Credit

Inventory
6 Commodity

heat yield in Saskatchewan and the July precipitation for 1960 through 1992

The modeled yields, in turn, explained approximately 94% of the

variability of UGGs grain handling earning. The yield depends on the
rain according to the regression equation Yield=15.5+0.0577*Rain,
R-squared = 43%.

Comprehensive Holistic All Risk Model

CHARM

CHARM plot showing the probability distribution of earning with

and without the impact of the weather. When the weather risk is
removed, the variation in EBIT is smaller, as shown by the lighter
curve, though expected value is the same. The probability
showing incurring a loss as a function of the size of the dollar
loss.

Definition: What is Value at

Risk?

Summary statistic that quantifies the exposure across

many assets/liabilities classes to market risk.
Identifies How Much one can loses if adverse market
conditions prevail.

Captures diversification or Portfolio Effect.

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

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.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

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

The Estimation of the 6 Major Risks

Risk

Instance(s)

Earning at
Risk

Possible
Alternatives

Weather

Impact on
harvested yields

11.5

None

Toxic waste

2.5

Insurance

Counterparty

Faliure of Supplier

4.3

Diversivicaiton/DD/
Contract

Credit

Payment Failure

1.6

Diversivicaiton/DD/
Contract

Inventory

Spoilage of
Inventory,
UnderStock/OverSto
ck

2.2

Operational Control

Commodity

Price Fluctuation

11.9

Insurance/ Futures

Environtment
Liability

The top 6 Risk based on its severe risk

1. Weather

4. Commodity

Weather Risk Exposure

ALTERNATIVE RISK
MANAGEMENT
APPROACHES
Retentio
n

Weather
Derivatives

The Insurance
Contract Idea

Retention
First, UGG had been and planned to continue
making large investments in storage facilities
(grain elevators).
Second, 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.
Third, although much of UGGs current business
could be characterized as a commodity business,
UGG tried to distinguish itself from competitors by
creating products 7 with brand names and by
providing on- going services to customers

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

Illustration of a Weather
Derivative

The Insurance Contract Idea

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

Risk Assessment to the weather problem

Estimate probability distribution of and

correlation among losses

Measure the expected loss individually and in
combination on ROE, EVA, 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

Environment Liabilities, Credit, Commodity,

Conterparty and Inventory Risk Exposure
2

Environment Liabilities
-Insurance
- Increase Control

Commodity

Diversivication of parnership to
avoid depedency with limited
number of partners
- Be more selective to choose
partner
-

-Futures
- Options

5
6

Credit

Inventory
-Increase Control
- Insurance

Counterpart
Diversivication of parnership to
avoid depedency with limited
number of partners
- Be more selective to choose
partner
-

Suggestion and Conclusion

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