Net Advisory Price Computation

The methodology used to determine net price received from each advisory service is similar to the procedure used in earlier AgMAS reports (e.g. Irwin et.al., 2006). The stream of collected recommendations is aligned in chronological order and returns to each futures and options hedging recommendation are calculated to arrive at a weighted average net price received by a farmer who precisely follows the marketing advice, as recorded by the AgMAS project. As mentioned earlier, all advisory services are assumed to use the same cash marketing strategy because cash live cattle recommendations are limited and short run in nature.

The net advisory price in the output-only hedging case is computed as the average cash sales price plus or minus gains/losses and brokerage costs associated with the futures and options transactions. In the input-output hedging scenario, the net advisory price is computed as the net advisory price from the output only scenario plus or minus gains/losses and brokerage costs

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associated with feeder cattle and grain transactions. A comparison of the net advisory price will be made to a quarterly average cash price benchmark. The following sections discuss specific aspects of computing the net price of each advisory service.

3.6.1 Feedlot Model

The feedlot model used in this study is based on the Focus on Feedlots dataset. This dataset was created by Kansas State University to provide basic feedlot information. Production in the theoretical model feedlot is assumed to be four hundred weights per year. In actual

feedlots, the most marketing occurs in the third quarter and the fewest in the fourth quarter due to weather conditions and feedstock sources available during the time the cattle are on feed. The seasonality of feedlot marketings is reflected in this production model and quarters are weighted using data from the Focus on Feedlots dataset. The third quarter receives the heaviest weight and the fourth quarter the lightest weight; together with the first and second quarters, the four quarters have a total per year marketing of four hundred weights. Weights for fed cattle

marketings per quarter are found in Table 2. If an advisory service gives a recommendation for a feedlot to hedge 50% of fourth quarter marketings, this translates to 0.39 hundred weights (50% * 4th _{quarter weight of 0.7833). This allows total gains and losses associated with futures and}

options to be comparable to estimated cash sales.

Input usage for each quarter is based on the production model of four hundred weights per year. Feeder cattle, corn and soybean meal are weighted to reflect marketing the weighted amount of marketings in a respective quarter. The average gain per head is based on the Focus on Feedlots dataset. The average market weight of a live fed steer between 1995 and 2004 was 1,250 pounds. The average start weight per head over this same time period was near 650

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pounds. For simplicity however, this study markets on average one hundred weight per quarter as opposed to one head. To market one head, 0.61 (650/1,250) hundredweight of feeder cattle must be put on feed.

In this hypothetical feedlot, each hundred weight is on feed for five months. If placed on feed January 15, it is marketed on June 15. As discussed previously 1/3 of each quarter‟s

marketings are made on the Wednesday closest to the 15th _{of the month, each month in the}

quarter. The placement for fed cattle marketed in Quarter 3 began February 15 and continued March 15 and April 15. Each quarter‟s weight may be found in Table 2. The low weights for feeder cattle as an input in Quarters 2 and 3 correspond to the low marketing of fed cattle in Q4.

Feed consumption for the hypothetical one hundredweight of marketed animal is calculated in the same manner as feeder calf placement. Average feed consumed per head was deduced partly through the Focus on Feedlots dataset and partly through (interview with ANSC professor). For this model, it was assumed that in the first month a feeder calf was on feed it consumed 7 bushels of corn and for each subsequent month, 11 bushels of corn were consumed, with 200 pounds of soybean meal were consumed equally each month. Quarter weights for both corn and soybean meal are found in Table 2.

3.6.2 Cash Marketing Strategy and Quantity Sold

The representative feedlot in this example is assumed to be large enough that the lumpiness of contracts is not an issue and therefore the manager can hedge the exact amount needed for both input and output hedges. Specifically, if a recommendation is given to hedge 25% of 4th _{quarter production, a feedlot is expected to hedge exactly 25%, not roughly 25%.}

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Furthermore, a constant production schedule is assumed, which assures that the representative feedlot will receive the quarterly average spot price for their cash purchases and marketings.

Occasionally, recommendations are given to “lift hedges as cattle are sold.” This recommendation is interpreted as lifting hedges on the Wednesday closest to the 15th _{of the}

month the hedge targets. It is also assumed the feedlot markets fed cattle continuously throughout the quarter and therefore a recommendation for hedging 25% of fourth quarter marketings lifting hedges as cattle are sold would have one-third of 25% lifted on the Wednesday closest the 15th _{of October, November and December.}

In addition to continuous production, there is also no production risk assumed in the calculations for net price received. It is assumed the feedlot will know the exact number of head that will be marketed in a given quarter and will back out the number of feeder cattle and

quantities of corn and soybeans to purchase