1 LGM-Dairy: A Cost Comparison With Bundled Options.

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LGM-Dairy: A Cost LGM-Dairy: A Cost Comparison WithComparison WithBundled OptionsBundled Options

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LGM-Dairy similar to the use of bundled option LGM-Dairy similar to the use of bundled option risk management strategyrisk management strategy Class III put options → floor milk revenueClass III put options → floor milk revenue Corn/SBM call options → feed cost cielingCorn/SBM call options → feed cost cieling

How does LGM-Dairy premiums compare to costs How does LGM-Dairy premiums compare to costs of setting a of setting a RevenueRevenue FloorFloor via bundled options? via bundled options?

For this analysis we: For this analysis we: Assume options perfectly divisibleAssume options perfectly divisible Compare costs under a variety of deductiblesCompare costs under a variety of deductibles Purchase insurance in April 2007 and 2008 Purchase insurance in April 2007 and 2008

given actual price data availabilitygiven actual price data availability

Cost Comparison of LGM-Dairy WithCost Comparison of LGM-Dairy WithOptions-Based Revenue ManagementOptions-Based Revenue Management

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For our example For our example Calculate gross and net premium costsCalculate gross and net premium costs Ending options value: Ending options value:

An options month’s final settle price if An options month’s final settle price if options monthoptions month

Exercise option at end of current monthExercise option at end of current month Choose nearest put or call to expected price to Choose nearest put or call to expected price to

establish similar minimum net revenueestablish similar minimum net revenue $70 broker fee/options contract$70 broker fee/options contract

Decision RuleDecision Rule: Insure 50% of milk production : Insure 50% of milk production for months where Class III price is considered for months where Class III price is considered a a goodgood price price


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MonthMonthApril 2007April 2007

MonthMonthApril 2008April 2008

Class III Class III ($/cwt)($/cwt)

CornCorn($/bu)($/bu)

SBMSBM($/ton)($/ton)

Class III Class III ($/cwt)($/cwt)

CornCorn($/bu)($/bu)

SBMSBM($/ton)($/ton)

Jun `Jun `0707 17.5717.57 3.713.71 195.37195.37 Jun `Jun `0808 18.3118.31 5.925.92 341.45341.45

Jul `Jul `0707 17.6117.61 3.763.76 198.33198.33 Jul `Jul `0808 18.7118.71 5.985.98 343.43343.43

Aug `Aug `0707 17.6917.69 3.753.75 201.40201.40 Aug `Aug `0808 18.8318.83 6.036.03 336.43336.43

Sep `Sep `0707 17.7917.79 3.743.74 203.77203.77 Sep `Sep `0808 19.0119.01 6.086.08 318.57318.57

Oct Oct `̀0707 17.2517.25 3.753.75 204.83204.83 Oct Oct `̀0808 18.8718.87 6.106.10 295.83295.83

Nov Nov `̀0707 17.1617.16 3.753.75 206.48206.48 Nov Nov `̀0808 18.8218.82 6.116.11 294.95294.95

Dec Dec `̀0707 16.7716.77 3.763.76 208.13208.13 Dec Dec `̀0808 18.7718.77 6.136.13 294.07294.07

Jan Jan `08`08 16.2416.24 3.793.79 209.20209.20 Jan Jan `09`09 18.3318.33 6.166.16 295.57295.57

Feb Feb `08`08 15.8315.83 3.833.83 210.64210.64 Feb Feb `09`09 18.2718.27 6.206.20 297.20297.20

Mar `08Mar `08 15.6715.67 3.863.86 212.07212.07 Mar `09Mar `09 18.1418.14 6.236.23 298.83298.83

April 2007 and April 2008 Expected PricesApril 2007 and April 2008 Expected Prices

A Cost Comparison of LGM-Dairy WithA Cost Comparison of LGM-Dairy WithOptions-Based Revenue ManagementOptions-Based Revenue Management

Note: All Class III prices are located in the 30% area of the empirical distributionNote: All Class III prices are located in the 30% area of the empirical distribution

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MonthMonthClass III Class III

Put ($/cwt)Put ($/cwt)

Class III Class III PremiumPremium($/cwt)($/cwt)

Corn Corn CallCall

($/bu)($/bu)

Corn Call Corn Call Premium Premium

($/bu)($/bu)

SBM SBM CallCall

($/ton)($/ton)

SBM Call SBM Call PremiumPremium($/ton)($/ton)

Jun `Jun `0707 17.5017.50 0.360.36 3.703.70 0.19620.1962 195195 10.3510.35

Jul `Jul `0707 17.5017.50 0.470.47 3.753.75 0.21420.2142 195195 10.3510.35

Aug `Aug `0707 17.7517.75 0.690.69 3.703.70 0.36750.3675 200200 11.4011.40

Sep `Sep `0707 17.7517.75 0.670.67 3.703.70 0.36750.3675 200200 14.4014.40

Oct Oct `̀0707 17.2517.25 0.730.73 3.803.80 0.36500.3650 210210 11.5011.50

Nov Nov `̀0707 17.0017.00 0.740.74 3.803.80 0.36500.3650 210210 14.2514.25

Dec Dec `̀0707 16.7516.75 0.830.83 3.803.80 0.36500.3650 210210 14.2514.25

Jan Jan `08`08 16.0016.00 0.770.77 3.903.90 0.40000.4000 230230 8.608.60

Feb Feb `08`08 15.7515.75 0.860.86 3.903.90 0.40000.4000 220220 13.0013.00

Mar `08Mar `08 15.5015.50 0.880.88 3.903.90 0.40000.4000 220220 13.0013.00

Options purchase data: April 26, 2007Options purchase data: April 26, 2007


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Put Put ($/cwt)($/cwt)

Class III Class III PremiumPremium($/cwt)($/cwt)

Corn Corn CallCall

($/bu)($/bu)

Corn Call Corn Call Premium Premium

($/bu)($/bu)

SBM SBM CallCall

($/ton)($/ton)

SBM Call SBM Call PremiumPremium($/ton)($/ton)

Jun `Jun `0808 18.2518.25 0.410.41 6.006.00 0.49250.4925 340340 14.4014.40

Jul `Jul `0808 18.7518.75 0.750.75 6.006.00 0.49250.4925 340340 20.7520.75

Aug `Aug `0808 18.7518.75 0.840.84 6.106.10 0.72620.7262 340340 25.1525.15

Sep `Sep `0808 19.0019.00 0.980.98 6.106.10 0.72620.7262 320320 28.8528.85

Oct Oct `̀0808 19.0019.00 1.141.14 6.106.10 0.89750.8975 290290 32.2532.25

Nov Nov `̀0808 18.7518.75 1.091.09 6.106.10 0.89750.8975 290290 35.2535.25

Dec Dec `̀0808 18.7518.75 1.211.21 6.106.10 0.89750.8975 290290 35.2535.25

Jan Jan `09`09 18.2518.25 1.241.24 6.206.20 0.97750.9775 300300 34.1034.10

Feb Feb `09`09 18.2518.25 1.381.38 6.206.20 0.97750.9775 300300 33.5033.50

Mar `09Mar `09 18.2518.25 1.471.47 6.206.20 0.97750.9775 300300 33.5033.50


Options purchase data: April 28, 2008Options purchase data: April 28, 2008

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LGM-Dairy: Expected Production/Feed UseLGM-Dairy: Expected Production/Feed Use

MonthMonthProduction Production

(cwt)(cwt)Corn Equiv. Corn Equiv.

(Tons)(Tons)SBM Equiv. SBM Equiv.

(Tons)(Tons)

JuneJune 4,3404,340 95.895.8 21.121.1

JulyJuly 4,1884,188 101.1101.1 22.322.3

AugustAugust 4,2404,240 97.697.6 21.521.5

Sept.Sept. 4,1884,188 98.898.8 21.821.8

Oct.Oct. 4,0234,023 97.697.6 21.521.5

Nov.Nov. 4,0754,075 93.793.7 20.720.7

DecDec 4,0384,038 94.994.9 20.920.9

JanJan 4,0634,063 94.194.1 20.820.8

FebFeb 3,9053,905 94.794.7 20.920.9

Mar Mar 4,2094,209 96.796.7 21.321.3

TotalTotal 41,26941,269 965.0965.0 212.8212.8

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LGM-Dairy: Covered Production/Feed UseLGM-Dairy: Covered Production/Feed Use

MonthMonthProduction Production

(cwt)(cwt)Corn Equiv. Corn Equiv.

(Tons)(Tons)SBM Equiv. SBM Equiv.

(Tons)(Tons)

JuneJune 2,1702,170 47.947.9 10.610.6

JulyJuly 2,0942,094 50.650.6 11.211.2

AugustAugust 2,1202,120 48.848.8 10.810.8

Sept.Sept. 2,0942,094 49.449.4 10.910.9

Oct.Oct. 2,0122,012 48.848.8 10.810.8

Nov.Nov. 2,0382,038 46.946.9 10.410.4

DecDec 2,0192,019 47.547.5 10.510.5

JanJan 2,0322,032 47.147.1 10.410.4

FebFeb 1,9531,953 47.447.4 10.510.5

Mar Mar 2,1052,105 48.448.4 10.710.7

TotalTotal 20,63520,635 482.5482.5 106.4106.4

All Class III pricesAll Class III pricesare inare in goodgood rangerange

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MonthMonthClass Class III PutIII Put

Corn Corn Call Call

SBM SBM Call Call

Total Total CostCost


PutPutCorn Corn Call Call

SBM SBM Call Call

Total Total CostCost

Jun `Jun `0707 781781 336336 109109 1,2261,226 Jun `Jun `0808 890890 843843 152152 1,8841,884

Jul `Jul `0707 984984 435435 115115 1,5351,535 Jul `Jul `0808 1,5711,571 889889 231231 2,6912,691

Aug `Aug `0707 1,4631,463 641641 123123 2,2262,226 Aug `Aug `0808 1,7811,781 1,2661,266 270270 3,3173,317

Sep `Sep `0707 1,4031,403 648648 157157 2,2082,208 Sep `Sep `0808 2,0522,052 1,2811,281 314314 3,6483,648

Oct Oct `̀0707 1,4681,468 636636 124124 2,2282,228 Oct Oct `̀0808 2,2932,293 1,5641,564 347347 4,2044,204

Nov Nov `̀0707 1,5081,508 611611 147147 2,2662,266 Nov Nov `̀0808 2,2212,221 1,5021,502 365365 4,0874,087

Dec Dec `̀0707 1,6761,676 619619 149149 2,4432,443 Dec Dec `̀0808 2,4432,443 1,5211,521 368368 4,3324,332

Jan Jan `08`08 1,5641,564 672672 8989 2,3262,326 Jan Jan `09`09 2,5192,519 1,6431,643 355355 4,5164,516

Feb Feb `08`08 1,6791,679 676676 136136 2,4912,491 Feb Feb `09`09 2,6942,694 1,6531,653 350350 4,6984,698

Mar `08Mar `08 1,8521,852 691691 138138 2,6812,681 Mar `09Mar `09 3,0943,094 1,6881,688 357357 5,1385,138

TotalTotal 14,37814,378 5,9655,965 1,2881,288 21,63121,631 TotalTotal 21,55721,557 13,84913,849 3,1093,109 38,51638,516

Options Purchase costs: April 2007 and April 2008Options Purchase costs: April 2007 and April 2008


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Gross costs: LGM-Dairy versus bundled options Gross costs: LGM-Dairy versus bundled options (($0 $0 DeductibleDeductible))


April 2007April 2007 April 2008April 2008

Gross CostGross Cost Cost/cwtCost/cwt Gross CostGross Cost Cost/CwtCost/Cwt

Bundled OptionsBundled Options

Class IIIClass III $15,101$15,101 $0.732$0.732 $22,279$22,279 $1.080$1.080

CornCorn $6,206$6,206 $0.301$0.301 $14,090$14,090 $0.683$0.683

SBMSBM $1,362$1,362 $0.066$0.066 $3,184$3,184 $0.154$0.154

TotalTotal $22,669$22,669 $1.099$1.099 $39,544$39,544 $1.917$1.917

LGMLGM $14,475$14,475 $0.715$0.715 $22,571$22,571 $1.094$1.094

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Gross costs under alternative deductiblesGross costs under alternative deductibles


April 2007April 2007 April 2008April 2008

Total Total Gross CostGross Cost

Gross Gross Cost/CwtCost/Cwt

TotalTotal

Gross CostGross CostGross Gross

Cost/CwtCost/Cwt

Put/Call OptionsPut/Call Options

$0 Deductible$0 Deductible $22,669$22,669 $1.099$1.099 $39,544$39,544 $1.917$1.917

$0.80 Deductible$0.80 Deductible $21,402$21,402 $1.037$1.037 $37,200$37,200 $1.803$1.803


LGM-DairyLGM-Dairy




Note: Under the options based strategy we reduce the options costs by Note: Under the options based strategy we reduce the options costs by the % reduction in GMG observed under the LGM-Dairy scenarios.the % reduction in GMG observed under the LGM-Dairy scenarios.

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Class III Put ($/cwt) Corn Call ($/bu) SBM Call ($/Ton)

MonthMonthClass Class

III Put III Put

Actual Actual Class Class

IIIIII

Put Put ValueValue

Corn Corn CallCall

ActualActualCornCorn

Corn Corn Call Call

ValueValue

SBM SBM CallCall

Actual Actual SBMSBM

SBM SBM Call Call

ValueValue

Jun `Jun `0707 17.5017.50 20.1720.17 00 3.703.70 3.303.30 00 195195 229.20229.20 34.2034.20

Jul `Jul `0707 17.5017.50 21.3821.38 00 3.753.75 3.423.42 00 195195 253.30253.30 58.3058.30

Aug `Aug `0707 17.7517.75 19.8319.83 00 3.703.70 3.243.24 00 200200 232.80232.80 32.8032.80

Sep `Sep `0707 17.7517.75 20.0720.07 00 3.703.70 3.373.37 00 200200 259.50259.50 59.5059.50

Oct Oct `̀0707 17.2517.25 18.7018.70 00 3.803.80 3.763.76 00 210210 272.50272.50 62.5062.50

Nov Nov `̀0707 17.0017.00 19.2219.22 00 3.803.80 3.853.85 0.050.05 210210 288.30288.30 78.3078.30

Dec Dec `̀0707 16.7516.75 20.6020.60 00 3.803.80 4.204.20 0.400.40 210210 324.50324.50 114.50114.50

Jan Jan `08`08 16.0016.00 19.3219.32 00 3.903.90 5.015.01 1.111.11 230230 352.00352.00 122.00122.00

Feb Feb `08`08 15.7515.75 17.0617.06 00 3.903.90 5.465.46 1.561.56 220220 375.70375.70 155.70155.70

Mar `08Mar `08 15.5015.50 18.0018.00 00 3.903.90 5.465.46 1.561.56 220220 336.50336.50 116.50116.50

Options Ending Values: April 2007Options Ending Values: April 2007


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Class III Put ($/cwt) Corn Call ($/bu) SBM Call ($/Ton)

MonthMonthClass Class

III Put III Put

Actual Actual Class Class

IIIIII

Put Put ValueValue

Corn Corn CallCall

ActualActualCornCorn

Corn Corn Call Call

ValueValue

SBM SBM CallCall

Actual Actual SBMSBM

SBM SBM Call Call

ValueValue

Jun `Jun `0808 18.2518.25 20.2520.25 00 6.006.00 7.257.25 1.251.25 340340 434.00434.00 94.0094.00

Jul `Jul `0808 18.7518.75 18.2418.24 0.510.51 6.006.00 6.576.57 0.570.57 340340 452.00452.00 112.00112.00

Aug `Aug `0808 18.7518.75 17.3217.32 1.431.43 6.106.10 5.685.68 00 340340 350.00350.00 10.0010.00

Sep `Sep `0808 19.0019.00 16.2816.28 2.722.72 6.106.10 5.485.48 00 320320 359.00359.00 39.0039.00

Oct Oct `̀0808 19.0019.00 17.0617.06 1.941.94 6.106.10 4.014.01 00 290290 254.50254.50 00

Nov Nov `̀0808 18.7518.75 15.5115.51 3.243.24 6.106.10 3.503.50 00 290290 256.00256.00 00

Dec Dec `̀0808 18.7518.75 15.2815.28 3.473.47 6.106.10 3.603.60 00 290290 258.50258.50 00

Jan Jan `09`09 18.2518.25 10.7810.78 7.477.47 6.206.20 3.823.82 00 300300 296.00296.00 00

Feb Feb `09`09 18.2518.25 9.319.31 8.948.94 6.206.20 3.523.52 00 300300 275.80275.80 00

Mar `09Mar `09 18.2518.25 10.4410.44 7.817.81 6.206.20 3.753.75 00 300300 286.00286.00 00

Options Ending Values: April 2008Options Ending Values: April 2008


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Options net costOptions net cost Per unit cost = Subtract ending option value Per unit cost = Subtract ending option value

from initial option costsfrom initial option costs Net cost Net cost ≡≡ Per unit cost x options amount Per unit cost x options amount

purchasedpurchased

LGM-Dairy net cost Net Cost ≡ LGM-Dairy premiums – indemnity

paid


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Net costs: LGM-Dairy versus bundled options (Net costs: LGM-Dairy versus bundled options ($0 $0 DeductibleDeductible))


April, 2007April, 2007 April, 2008April, 2008

Net CostNet Cost Cost/CwtCost/Cwt Net CostNet Cost Cost/CwtCost/Cwt

Put/Call Options Put/Call Options

Class IIIClass III $15,101$15,101 $0.732$0.732 -$54,092-$54,092 -$2.621-$2.621

CornCorn -$1,740-$1,740 -$0.084-$0.084 $10,927$10,927 $0.530$0.530

SBMSBM -$7,465-$7,465 -$0.362-$0.362 $411$411 $0.020$0.020

TotalTotal $5,896$5,896 $0.286$0.286 -$42,754-$42,754 -$2.072-$2.072

LGMLGM $14,475$14,475 $0.715$0.715 -$27,028-$27,028 -$1.309-$1.309

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Net costs under alternative deductibles: Net costs under alternative deductibles: April 2007April 2007


Gross Gross CostCost


Net Net CostCost

Net Net Cost/CwtCost/Cwt





LGM-DairyLGM-Dairy




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Gross Gross CostCost


Net CostNet CostNet Net

Cost/CwtCost/Cwt


$0 Deductible$0 Deductible $39,544$39,544 $1.917$1.917 -$42,754-$42,754 -$2.072-$2.072

$0.80 Deductible$0.80 Deductible $37,200$37,200 $1.803$1.803 -$40,211-$40,211 -$1.949-$1.949


LGM-DairyLGM-Dairy

$0 Deductible$0 Deductible $22,571$22,571 $1.094$1.094 -$26,667-$26,667 -$1.292-$1.292



Net costs under alternative deductibles: Net costs under alternative deductibles: April 2008April 2008

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Gross Cost Comparison SummaryGross Cost Comparison Summary $0 deductible$0 deductible

Depending on expected prices, gross costs Depending on expected prices, gross costs of options may or may not be more than of options may or may not be more than LGM-DairyLGM-Dairy

Usual case is for bundled options to be more Usual case is for bundled options to be more expensiveexpensive

Reasonable deductibleReasonable deductible Gross options costs much greater than Gross options costs much greater than

LGM-DairyLGM-Dairy


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Net Cost Comparison SummaryNet Cost Comparison Summary Results obtained are not able to be generalized Results obtained are not able to be generalized

except that it depends on relative movements of except that it depends on relative movements of prices after contract initiationprices after contract initiation


1 LGM-Dairy: A Cost Comparison With Bundled Options.

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