1. 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.
2. Agriculture and inparticular industry was one of civilizations oldest industriesThe industry is quite
volatile, characterizes by boom and bust cycles, and its roots in the forces of supply anddemand in
the global market Grain supplies were variable due to natural forces such as pests, disease and
weather.
3. To reduce volatility, many countries create policies inCanada for wheat (barley andoats/board gain)
regulated by Three largestCanadian Wheat Board (CWB) distributor in that mandated monopsony
1998 were Saskatchewan Wheat Pool,Grain distributor like UGG Agricore, and were important
UGGintermediateries between the farmer and the end market.
4. The Canadian agriculture industry was under pressure from several directions, and many farmers
disagreed with CWB policies and its In 1995, goverment monopsony power. repealed legislation that
kept gain transportation cost fixed (and low) for many years, and reviewing other grain transpotation
and distribution systems.
5. Since 1993, derive about United Grain Growers 70% of its income from grain operation Strategy:
UGG spent about $65 To modernize its grain handlingmillion on acquiring and business Issued
building its non-grain limited To provide handling business voting farmers with 1993 common
services beyond restructured shares on grain handling itself as a TorontoBuild new HTP elevators,
public Stock corporation Exchangeupgrade existing elevator, Established funding activities in
1906Initial Public Offering Core Division Grain Handling Merchandising
6. 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
7. The Industry Climate Manitoba Pool Alberta Pool Takeover UGG Elevators Rather than suffer
substantial dilution of their existing investment, the bidders withdrew their offer Two bidders merged
from Agricore
8. The Industry Climate UGG formed a strategic ADM would gain a secure grain supply alliance
with Archer for its processing operations Daniels Midland Company UGG could plan more
efficiently for future transportation and grain handling demands, and increase market shares UGG
also formalized a partnership with Marubeni Corporation
9. The Willis Report 1992, shareholders successfully sued their directors because the firm did not
hedge its grain risk when prices were falling Emerging interest in risk management prompted UGG
to participate in abenchmarking review of best risk management practices in its Treasury department
10. On site Risk BrainstormingFebruary 11, 1997, twenty UGG senior managersand other employees
met for an on site riskbrainstorming, with task : 1. to identify the risk the firm faced 2. to rank them,
by polling the group, in relative importance to the firm
11. Willis AttentionWillis focused its attention on the first group ofsix 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
12. Earnings at Risk (EaR) Which had been developed by the financial community, to describe
aggregate risk. EaR expressed a "worst- case" loss, set against a benchmark of expected profit,
within a specified confidence or probability level.
13. CHARMCHARM (Comprehensive Holistic All Risk Model)generated graphical output in several
formats tohighlight the various aspect of each risk.The most general format was a
probabilitydistribution showing the probability of incurringa loss as a function of the size of the dollar
loss .Cox had the information to do something toimprove the firms risk management
performanceand potentially reduce UGGs long term cost ofrisk
14. 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
15. Six Major Risk Risk Instance(s) Earning at Risk Possible Alternatives Weather Impact on harvested
11.5 Weather Derivatives yields and InsuranceEnvironment Toxic waste 2.5 Insurance and
controlCounterparty Failure of Supplier 4.3 Diversification/Due diligence/Contract Credit Payment
Failure 1.6 Diversification/Due diligence/Contract Inventory Spoilage of Inventory, 2.2 Operational
Control, UnderStock/OverStock and InsuranceCommodity Price Fluctuation 11.9 Futures and
Options
16. List of RiskBusiness interruption Employee liability Pension plan performanceCargo/marine
exposure Employee performance ProcessCivil disturbance /fidelity compliance/executionCommodity
basis/ price environmental Product liabilityCompetition Foreign exchange Product
performanceConsumer preferences Head office catastrophe Quebec separates from Industrial
espionage CanadaContractual no-performance Intellectual property R&D venturesCredit/receivables
Interest rates Regulatory (CWB, transportation)Counterparty Inventory Stock market crashDirectors
& officers Labor strikeexposure Leverage (too much or too Strategic planningData accuracy little)
Technology (choice, use of)Disease/spoilage Loss of key personnel transportationComputer system
failure Mergers and acquisition unionizationEmployee injury Major property exposure weather
17. Willis Group Assessment 1 Weather 2 Environment Liability The Major Risks are 3 Counterparty
41Risks 4 Credit 5 Inventory 6 Commodity
18. All-Wheat yield in Saskatchewan and the July precipitation for 1960 through 1992The modeled
yields, in turn, explained approximately 94% of the variability of UGGsgrain handling earning. The
yield depends on the rain according to the regressionequation Yield=15.5+0.0577*Rain, R-squared =
43%.
19. 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.
20. 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
21. 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
22. 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 (Portfolio Effect)
23. The Estimation of the 6 Major Risks Risk Instance(s) Earning at Risk Possible Alternatives Weather
Impact on harvested 11.5 None yieldsEnvirontment Toxic waste 2.5 InsuranceLiability Counterparty
Faliure of Supplier 4.3 Diversivicaiton/DD/Cont ract Credit Payment Failure 1.6
Diversivicaiton/DD/Cont ract Inventory Spoilage of Inventory, 2.2 Operational Control
UnderStock/OverStock Commodity Price Fluctuation 11.9 Insurance/ Futures
24. The top 6 Risk based on its severe risk 2. Environmental 1. Weather Liabilities 3. Credit Its effect
on grain volume The Toxic waste released to The Failure of UGG Partner would disturb the
Business external environment could to pay their Debt to UGG raise social risk and could would
Disturb UGG Cash raise penalty from Flow government 4. Commodity 5. Couterparty Exposure 6.
Inventory The Fluctiation of The Probability of UGG The Understock condition Commodity Price
could Suppliers (Upstream and might result the loss of result a severe Downstream) not to market
opportunity disturbance to UGG meet their contract The Overstock inventory business obligation
would result higher risk since the grain price are very fluctuative
25. Weather Risk Exposure 1 ALTERNATIVE RISK MANAGEMENT APPROACHES Retention Weather
DerivativesThe Insurance Contract Idea
26. 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
27. 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.
28. Illustration of a Weather Derivative
29. 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.
30. 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
31. Environment Liabilities, Credit, Commodity, Conterparty and Inventory Risk Exposure Environment
Liabilities2 -Insurance - Increase Control Credit 3 - Diversivication of parnership to avoid depedency
with limited number of partners - Be more selective to choose partner Commodity4 -Futures -
Options Counterpart 5 - Diversivication of parnership to avoid depedency with limited number of
partners - Be more selective to choose partner Inventory6 -Increase Control - Insurance
32. Suggestion and ConclusionWe propose the use of insurance for the weather uncertainty (option 3)
due :1. Broader Loss Coverage, not only weather risk2. The premium of insurance cost can be
reduced3. Company would much more safe