Hedging Cash Flows from Commodity Processing

Agribusinesses make long-term plant-investment decisions based on discounted cash flow. It is therefore incongruous for an agribusiness firm to use cash flow as a plant-investment criterion and then to completely discard cash flow in favor of batch profits as an operating objective. This paper assumes that cash flow and its stability is important to commodity processors and examines methods for hedging cash flows under continuous processing. Its objectives are (a) to determine how standard hedging models should be modified to hedge cash flows, (b) to outline the differences between cash flow hedging and profit hedging, and (c) to determine the effectiveness of hedging in reducing cash flow variability. A cash flow hedging methodology is developed. This methodology is similar to that used for batch profit hedging. This methodology balances the daily cash flow destabilizing effect of futures positions against the periodic cash flow destabilizing effect of cash price changes. The resulting cash flow hedges are simulated for soybean processors. These hedges are less effective than batch profit hedging. The reduction in cash flow variance achieved through hedging, though small, is nonetheless statistically significant.

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2005 Conference, St. Louis, MO, April 18-19, 2005

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