The feasibility of utilizing financial futures hedging by the agricultural borrower Public Deposited

http://ir.library.oregonstate.edu/concern/graduate_thesis_or_dissertations/ht24wm65z

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  • Borrowed funds finance a majority of equipment purchases and production costs in agriculture. The costs of borrowing, however, have not been stable nor has the determination of interest payments remained the same in recent years. As interest rates become increasingly volatile and variable rate loans replaced constant rate loans, the borrower has become more exposed to the risks and uncertainties derived from cost variances for borrowed funds. The establishment and development of financial futures during the l970s provided an avenue for interest rate hedging. A participant in the financial futures market could conceivably establish an acceptable interest rate or return on an investment in much the same sense that a commodity trader can use the commodity futures to protect a price position. The original intent of the financial futures, however, was to serve the needs of larger financial institutions. This thesis explores the feasibility of utilizing these futures for the targeting of acceptable loan cost rates and the protection of an established interest rate. This study is an attempt at determining the broader applicability of interest rate hedging in agriculture. Basis activity, forward timing abilities, and price change coordination capacities were explored for two futures contracts in short-term financial instruments. Basis activity was characterized in terms of variance and closing price ranges and provided an indication of a general applicability of financial futures for interest rate hedging. The results for the forward timing tests indicated limited predictive ability or price determination capacity for these futures. Tests of the price coordination function of these futures indicated a high degree of correlation between price changes in a futures and a related cash market. Ratios of optimal loan sizes per futures contract size were determined from this third analysis, and coupled with maturity considerations provided an indication of what were the minimum levels of borrowing activity necessary for a worthwhile futures hedging activity. Overall, there appeared to be consistent and advantageous hedging opportunities provided a participant met some relatively large minimum needs requirements. These futures contracts are best at serving the needs of very large producers, marketers or retailers with short-term borrowing needs. These futures are not a viable mechanism for interest rate hedging for a majority of the agricultural producers in the Pacific Northwest.
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