Agricultural Finance

HÉLYETTE GEMAN is Director of the Commodity Finance Centre at Birkbeck, University of London and Research Professor at Johns Hopkins University. She is a graduate of Ecole Normale Supérieure in Mathematics, holds a Masters degree in Theoretical Physics and a PhD in Probability from the University Pierre et Marie Curie; and a PhD in Finance from the University Paris Sorbonne. Professor Geman has published more than 130 papers in top international finance, insurance and energy economics Journals, became in 1993 a Member of Honour of the French Society of Actuaries for her work on Catastrophic risk; received in 1994 the first Prize of the Merrill Lynch awards for her research on Asian and complex options; was named in 2004 in the Hall of Fame of Energy Risk. She has been a scientific advisor to major financial institutions, energy and mining companies and commodity houses for the last 21 years, covering the spectrum of interest rates, crude oil and natural gas, metals and agricultural, including water, fertilizers and land. Her book Insurance and Weather Derivatives was published in 1999 by RISK Publications; her book entitled Commodities and Commodity Derivatives: Energy, Metals and Agriculturals published by Wiley Finance in 2005 has become the reference in industry and Master programmes worldwide. Prof Geman counts among her PhD students Nassim Taleb. She is presently on the Board of a green energy company and an active participant in a ‘precision farming’ project involving 12,500 farmers in East Africa.

• Acknowledgments xiiiAbout the Author xvPreamble xvii1 Physical and Financial Agricultural Markets 11.1 Agriculture and the Beginning of Human Sedentarization 11.1.1 Some recent numbers 21.1.2 The growing role of Africa 21.2 The Outlook of Agricultural Commodities Markets 31.2.1 Recent mergers and acquisitions 31.2.2 ‘Trading places’: from the abcd to the now 41.2.3 The physical markets 91.2.4 The global flows of commodities 101.2.5 Back to the future: a new age for barter 111.2.6 The sources of information in agricultural commodity markets 121.3 History of Commodity Futures and Spot Markets 121.3.1 The actors in financial markets 121.3.2 The actors in agricultural commodity exchanges 131.3.3 The growth of Futures markets exchanges and the recent mergers 141.3.4 Futures markets and price volatility 151.3.5 The role of indexes in the creation of efficient commodity spot markets 161.3.6 Commodities and numéraire 171.4 Shipping and Freight 171.4.1 International trade 181.4.2 Price formation in freight markets 182 Agricultural Commodity Spot Markets 252.1 Introduction 252.2 Price Formation in Agricultural Commodity Markets 252.3 Volatility in Agricultural Markets 272.3.1 Volatility of the price level versus return in agricultural commodity markets 322.3.2 Which factors drive volatility? 362.3.3 Conclusion 383 Futures Exchanges – Future and Forward Prices – Theory of Storage – The Forward Curve 393.1 Major Commodity Exchanges 393.2 Forward Contracts 413.3 Futures Contracts 433.3.1 Definition 433.3.2 Exchange of Futures for physicals (efp) 443.4 Relationship between Forward and Futures Prices 453.5 Example of a Future Spread 473.6 Inventory and Theory of Storage 473.6.1 Spot and Futures prices volatilities 493.6.2 Development of the theory of storage: inventory and prices 513.7 The Benefits of Forward Curves 523.7.1 Trading strategies around forward curves 523.7.2 Example of a seasonality-based Futures spread 533.7.3 From linear to convex payoffs 543.8 Stochastic Modeling of the Forward Curve 554 Plain Vanilla Options on Commodity Spot and Forward Prices. The Bachelier–Black–Scholes Formula, the Merton Formula, the Black Formula 594.1 Introduction 594.2 Classical Strategies involving European Calls and Puts 624.2.1 Straddle 624.2.2 Strangle 624.2.3 Call spread or vertical call spread 634.2.4 Butterfly spread 644.3 Put–Call Parity for a Non-dividend Paying Stock 644.4 Valuation of European Calls: the Bachelier–Black–Scholes Formula and the Greeks 664.4.1 Consequences of the Black–Scholes formula 704.4.2 The Greeks 714.5 The Merton (1973) Formula for Dividend-paying Stocks 754.6 Options on Commodity Spot Prices 774.7 Options on Commodity Futures: the Black (1976) Formula 784.8 Monte-Carlo Simulations for Option Pricing 794.8.1 The founding result 794.8.2 Monte-Carlo methods for plain vanilla options on non-dividend paying stocks 804.8.3 Monte-Carlo methods for plain vanilla options on the spot commodity 824.9 Implied Volatility, Smile, and Skew in Equity Option Markets 834.10 Volatility Smile in Agricultural Commodity Markets 864.10.1 W here is the liquidity in agricultural commodity option markets? 864.10.2 Extracting the implied volatility from options on commodity Futures 865 Commodity Swaps, Swaptions, Accumulators, Forward-Start, and Asian Options 895.1 Swaps and Swaptions 895.2 Accumulators 925.3 Forward-Start Options (or Calendar Spread Options on the Spot Price) 935.4 Asian Options as Key Instruments in Commodity Markets 955.4.1 Approximation of the arithmetic average by a geometric average 965.4.2 Approximation of the distribution of the arithmetic average by a log-normal distribution 975.4.3 Monte-Carlo simulations for Asian options valuation 985.4.4 Exact results (Geman and Yor, 1993) 1005.5 Trading the Shape of the Forward Curve through Floating-strike Asian Options 1026 Exchange, Spread, and Quanto Options in Commodity Markets 1036.1 Exchange Options 1036.2 Commodity Spread Options and Their Importance in Commodity Markets 1056.3 Commodity Quanto Options 1097 Grain Cereals: Corn, Wheat, Soybean, Rice, and Sorghum 1137.1 Introduction 1137.2 Corn 1137.3 Wheat 1187.3.1 W heat trading 1197.3.2 Global wheat 1197.3.3 The wheat supply chain 1207.4 Soybeans 1237.5 Rice 1267.6 Sorghum 1298 Sugar, Cocoa, Coffee, and Tea 1338.1 Sugar 1338.1.1 Links of sugar with other commodities 1348.1.2 Sugar trading 1358.1.3 The European Union 1368.1.4 Special relations of the eu with other countries 1368.1.5 The United States 1368.1.6 Special relations of the usa with other countries 1378.1.7 Brazil 1378.1.8 China 1388.1.9 India 1388.1.10 Thailand 1398.1.11 Australia 1398.1.12 Guatemala and Cuba 1398.1.13 Sugar cane in Mauritius 1408.2 Cocoa 1408.3 Coffee 1468.4 Tea 1499 Cotton, Timber and Wood, Pulp and Paper, Wool 1539.1 Cotton 1539.2 Lumber and Wood 1569.3 Pulp and Paper 1589.3.1 Pulp NBSK and BHKP indexes 1599.3.2 Pulp US NBSK index 1609.3.3 Pulp BHKP China 1609.3.4 Pulp NBSK China 1619.3.5 When bank notes go plastic 1619.4 Wool and Cashmere 1629.4.1 Cashmere 1639.4.2 From the Kashmir Goat to high quality yarns 16410 Orange Juice, Livestock, Dairy, and Fishery 16510.1 Orange Juice 16510.2 Livestock 16610.2.1 Livestock markets 16710.2.2 Cattle 16810.2.3 Hogs 16910.2.4 Pork bellies 16910.2.5 The US live cattle contract specifications 17010.2.6 Australia 17110.2.7 The USA 17110.3 Dairy 17210.4 Fish Markets 17310.5 Poultry and Eggs 17411 Rubber, Palm Oil, and Biofuels 17711.1 Rubber 17711.2 Palm Oil 18011.2.1 The oil palm and palm oil 18111.2.2 Markets 18211.3 Ethanol, Biofuels, and Biomass 18312 Land, Water, and Fertilizers 18712.1 Land Types, Yields, and Erosion 18712.1.1 Yield-at-risk 18712.1.2 Land competition 18812.1.3 Farmland in the USA 18812.2 Fertilizers 18912.2.1 Fertilizer markets 19112.2.2 Fertilizer Index, corn, and wheat price trajectories over the period 1991 to 2011 19312.2.3 Fertilizer producing companies and share price returns over the period 2004 to 2011 19312.2.4 A factor model for the share returns of fertilizer firms 19812.3 Water and its crucial Role in the World Economy 20712.3.1 The case of Australia, China, and Saudi Arabia 20812.3.2 The case of Brazil 20812.3.3 Competition for electricity, water, and land 20912.4 Projections for the Future of Agriculture 20912.4.1 Farm insurance 21012.4.2 Estimating long-term agricultural supply 21012.4.3 Market concentration 21112.4.4 Spare capacity 21112.5 Subsidies and Export Bans 21112.5.1 Subsidies 21212.5.2 Export bans 21212.6 Market-oriented Farming 21212.6.1 Open wheat market takes root in Canada 21312.6.2 Kansas City wheat Futures trading coming to an end after 157 years 21312.6.3 China food needs 21413 Infrastructure and Farming Management in the Digital Age 21713.1 Introduction 21713.2 Agricultural Infrastructure 21813.2.1 Total factor productivity 21813.2.2 Climate change 21913.2.3 Irrigation and increased productivity 21913.2.4 Trends in irrigation 21913.2.5 Storage 22013.2.6 Grain elevators 22013.2.7 Soybean crushers 22013.2.8 The Brave New World of Monsanto 22113.2.9 Infrastructure in sub-Saharan Africa 22113.2.10 Gabon: after black gold, green gold? 22113.2.11 Agricultural Transformation Agenda (ATA) in Nigeria 22213.2.12 Digital age on the farm: prescriptive planting 22213.2.13 Sugar biofactory for ethanol in Brazil 22413.2.14 After ethanol, railway, and natural gas 22413.2.15 From iron ore mining to cattle farming in Australia 22513.2.16 Robots for cow milking 22513.2.17 Containers for agricultural commodities 22613.2.18 Singapore as a hub for refrigeration containers 22613.2.19 The trip of the banana 22613.2.20 Energy, water, and infrastructure for DAP and agriculture in Saudi Arabia 22713.3 Country Risk: the Example of Ukraine in 2014 22713.4 Analyzing the Risks Involved in an International Wheat Tender Offer 22813.5 Weather Risk and Weather Derivatives 22914 Investing in Agricultural Commodities, Land, and Physical Assets 23314.1 Purchase of Commodity Futures 23314.2 Purchase of Commodity Options and Structured Products 23514.3 Commodity Index Investing 23614.3.1 Some prominent commodity indexes 23614.3.2 How commodity indices are constructed 23814.3.3 Commodity-linked bonds 23914.4 Investing in Commodity-related Equities 23914.5 Investing in Land 24014.5.1 The US case 24114.5.2 The world case 24114.6 Acquisition of Infrastructure and Physical Assets 24214.6.1 Valuation of a transformation plant using a real options approach 24214.6.2 D CF approach to the valuation of a transformation plant 24314.6.3 Valuation of a silo (or an aquifer, or any storage facility) 24514.7 Conclusion 247Glossary 248References 252Index 257