Class Office Hours: Monday and Friday. 2:00-3:00 pm GSB 503.

(1)

AREC 487- Managing Market Risk In Resource Industries Winter Term 2010

Instructor: Philippe Marcoul Office: 503 GSB. Ph: 1-780-1048-1094

Email: [email protected] : Please include AREC 487 in all email headers.

Class Meeting Time: Monday, Wednesday and Friday. 1:00-1:50 p.m. GSB 553 Class Office Hours: Monday and Friday. 2:00-3:00 pm GSB 503.

Course Overview and Objectives:

AREC 487 studies the mechanics and economic functions of market risk management and the functions of commodity futures and options markets. This knowledge is applied to market risk management for resource industries such as agriculture, forestry and energy. Topics include the theory and practice of hedging, intertemporal price formation and uses in business management.

Theory and tools will be applied to specific examples. Students by the end of the course will:

• understand the concept of market risk and how to measure market risk

• understand futures and forward contracts and how to value these contracts

• understand and apply hedging to resource industries in agriculture, forestry and energy

• understand the use of options and how to price simple options

• apply derivative theory to other risk management tools such as weather derivatives

• understand the role of risk management in contracting

Course Material: Course Pack (based on Jim Unterschultz's pack) and course slides Other references not listed in the course pack:

• Alberta Agriculture Marketing Principles - Marketing Principles. Alberta Agriculture and Rural Development website

http://www1.agric.gov.ab.ca/$department/deptdocs.nsf/all/sis8570

• Canadian Farm Business Management Council. 2004. Managing Farm Business Risk.

Accessed January 2, 2009.

(

) Accessed January 2 2009.

http://www.farmcentre.com/Resources/Detail.aspx?id=652bcdd6-f80d-4580-ab68- ccb101e3c280

• Harwood. Joy, Richard Heifner, Keith Coble, Janet Perry, and Agapi Somwaru 1999.

Managing Risk in Farming: Concepts, Research, and Analysis. United States Department of Agriculture Agricultural Economics Report No. 774. 136 pp, March 1999.

)

http://www.ers.usda.gov/publications/aer774/

• Hull, J.C. 1998. Introduction to Futures and Options Markets 3rd Edition. Prentice Hall.

(Note that the 4th edition is referenced in the course pack)

accessed January 2, 2009.

Policy about course outlines can be found in §23.4(2) of the University Calendar.

(2)

Code of conduct:

The University of Alberta is committed to the highest standards of academic integrity and honesty.

Students are expected to be familiar with these standards regarding academic honesty and to uphold the policies of the University in this respect. Students are particularly urged to familiarize themselves with the provisions of the Code of Student Behavior (online at www.uofaweb.ualberta.ca/secretariat/studentappeals.cfm ) and avoid any behavior which could potentially result in suspicions of cheating, plagiarism, misrepresentation of facts and/or participation in an offence. Academic dishonesty is a serious offence and can result in suspension or expulsion from the University."

Grading:

• Futures Trading Exercise – 20% for report plus 5% for participation in class/trade activity (report due Monday April 6, 4:30 p.m.) (individual work)

• Assignments (3) 25% (Due dates approximately Jan. 23, Feb. 27 and March 27) (individual work)

• Quizzes (4-5) 25% and based on best 4 of 5 quizzes (Tentative Dates: Fridays at beginning of class for 10-20 minutes except for the last quiz. Jan 16, Jan 30, Feb 13, March 13 and April 8)

• Final Exam - 25%.

The grading scheme will be "relative". There are no fixed term marks or class average that determines the final grade. The term marks are graded in percent (i.e. out of 100) and then the final letter grade is assigned from the term marks.

Late Assignments and term work will receive a penalty of 25% per day. Please contact Philippe Marcoul ahead of time if there are extenuating circumstances (e.g. health, bereavement) for late work.

Final examination (25%) The final will be “cumulative” and will test whether students have acquired the basic concepts of option and futures.

Futures and Options trading exercise (20%) (Tradesim). Details on the start times will be given in the 2nd week of classes. See attachment for more details on the trading exercise. See page 10.

Quizzes. There will be five quizzes during class time. Each quiz will be 10-20 minutes long and at the beginning of the class. Topics to be covered in the quiz will be announced one class before the quiz. The best four quizzes, each weighted at 5% the term mark, will be used to determine the final grade. Only under exceptional circumstances will make-up quizzes be provided for those who miss a quiz.

Topics: Other readings and topics may be added as the course progresses. Selected readings from the course pack will be required. The other readings provide alternative sources of information on the topic. The order of the topics may change.

(3)

Tentative Summary of Topics

1. Introduction to futures, options and market risk management.

2. Futures Theory 3. Basis and hedging

4. Market Analysis and Price Forecasting: Fundamental and Technical analysis 5. Commodity Swaps

6. Options Theory, Option Pricing and Application to Risk Management 7. Weather Derivatives

8. Contracting and Identity Preserved Chains: How to share risk and price discovery?

9. Developing a Risk Management Strategy and Plan Detailed Topics With Readings.

1. Introduction to futures, options and market risk management

Derivative Defined, terminology Long/Short, Hedging defined Market Mechanics: Margin, Open Interest

Speculators versus hedgers Readings:

Course Pack:

Miller: pp 1-5

Carter: pp. 7-27. skim 28-55 Kolb (pp. 84-100):

Hull. 1997. Options Futures and Other Derivatives 3rd Edition. (Starts p. 112). Sections 2.1- 2.8, 2.12

Other Readings

Fundamental Carter. Ch 5

Purcell et al. Ch. 3 (Fundamental Analysis) Technical Analysis

Carter. Ch. 6

Purcell et al. Chs. 4-6 (This is an excellent discussion on applications to agriculture commodities)

Lots of information on the internet

5. Commodity Swaps: An extension of Futures and Forwards

Application to oil and gas. Basis Swaps Valuation

Emerging uses in Agriculture Readings

Course Pack

Das, S. 1994. (starts p. 315) Chapter 16: Commodity Swaps and Related Derivatives in Swap and Derivative Financing. Revised Edition. Irwin Professional Publishing.

Other Readings

Hull. 1998 or 2002. Ch. 6: Swaps. (Hull only discusses currency and interest rate swaps.) Kolb. Chapter 20: The Swaps Market: Introduction (Kolb discusses Currency and Interest

rate swaps. Chapters 21 and 22 go into more depth in financial swaps)

6. Options Theory, Option Pricing and Application to Risk Management

Hedging using options

Options strategies such as windows (collars) combinations Applications to livestock

Option valuation using Black-Scholes and Black models (analytic) Option valuation using binomial model (numerical)

Readings

Course Pack:

Wilmott, P. 2000. (starts p 373) Chapter 2: Derivatives in Paul Wilmott on Quantitative Finance. John Wiley and Sons.

Tompkins, R.G. 1994. (starts p 402)Chapter 1: The Basics of Options in Options Analysis Revised Edition. Macmillan Press.

Tompkins, R.G. 1994. (starts p. 424) Chapter 2: Basic Concepts in Options Pricing in Options Analysis Revised Edition. (Has Black-Scholes Formula, volatility)

Chriss, N.A. 1997. (starts p. 480) Hedge Parameters pp. 162,180-181 in Black-Scholes and Beyond: Option Pricing Models. (summarizes the "Greeks")

Tompkins, R.G. 1994. (starts p. 456) Chapter 3: Advanced Concepts in Options Pricing. Pp.

55-76 in Options Analysis Revised Edition. (Black model, discussion of the "Greeks"

(6)

Hull, J.C. 2002. (starts p. 484) Chapter 10: Introduction to Binomial Trees in Fundamentals of Futures and Options Markets. Fourth Edition. Prentice Hall.

Hull, J.C. 2002. Chapter 17:(starts p 498) Valuation Using Binomial Trees. Pp. 354-363 in Fundamentals of Futures and Options Markets. Fourth Edition. Prentice Hall.

Other Readings

(7)

Hull. 2002. Chapter 20. pp. 414-415

8. Contracting and Identity Preserved Chains: How to share risk and price discovery?

Questions: Do derivatives markets have a role?

Readings

Course Pack: No readings

Other Readings

Ward, C.E. (2000w). A Review of Causes for and Consequences of Economic Concentration in the U.S. Meatpacking Industry. Current Agriculture, Food & Resource Issues 3/2002: 1- 28. Retrieved December 17, 2003 from the World Wide Web: http://www.CAFRI.org Note: CAFRI (Current Agriculture, Food & Resource Issues) has other articles on supply chains and

identity preservation. Also see AGECON Search website.

.

9. Developing a Market Risk Management Strategy

Readings

Course Pack

Wilmott, P. 2000. (starts p. 577) Chapter 59: Derivative Ups. In Paul Wilmott Introduces Quantitative Finance. Volume 2. John Wiley and Sons.

Purcell, W. D. and S. R. Koontz. 1999. (starts p. 592) Chapter 11: Price Risk Management Strategies. In Agricultural Futures and Options Principles and Strategies 2nd Edition.

Other Readings

Managing Farm Business Risk. Ch 1