Benefits and costs of hedging the CAD/USD exchange rate and its effect on mitigating CWB Wheat Pool account deficit probabilities
Date
2008-01-12
Authors
Journal Title
Journal ISSN
Volume Title
Publisher
ORCID
Type
Degree Level
Masters
Abstract
The CWB has the stated objective of increasing producer returns through maximizing sales revenue and minimizing operating costs. To maximize producer returns the CWB derives value from single-desk selling, price pooling and the initial price guarantee.
The initial price allows the CWB to offer a price floor to producers which is guaranteed by the Federal government. This guarantee has come under review in recent World Trade Organization (WTO) negotiations with opponents stating that the Federal government is unfairly subsidizing producers. Therefore developing methods to hedge the initial payment and remove the CWB dependency on the Federal government guarantee has taken on considerable importance.
Hedging the initial price has two components, the first is commodity risk, and the second is currency risk. Commodity risk basically consists of the risk that wheat prices decrease significantly from the announcement of the initial payment resulting in a wheat pool account deficit. Currency risk relates to the risk of the Canadian dollar (CAD) increasing vis-à-vis the United States dollar (USD) resulting in lower wheat prices. This is due to the fact most sales are made in USD, necessitating the conversion of USD for CAD in order to pay Canadian producers. Given recent increases in exchange rate volatility this later risk is important.
The goal of this study is to evaluate the currency risk present in the initial payment and to examine alternate means of mitigating this risk. A number of call option strategies will be evaluated to determine its ability to reduce the probability of a wheat pool account deficit by offsetting the effect of a rising CAD.
The policy variables analyzed in the thesis are the initial payment as a percentage of the Pool Return Outlook for wheat and the strike price of the call options purchased. Therefore the study will examine the effect of inputting varying initial payment levels and different strike prices for the call options in the model. This will allow for quantifiable insight into cost versus risk reduction comparisons. These comparisons will be useful in determining the most efficient mode of action for the CWB.
Description
Keywords
Wheat pool account hedging, CWB deficit probabilities, Exchange rate risk
Citation
Degree
Master of Science (M.Sc.)
Department
Agricultural Economics
Program
Agricultural Economics