Corporate Financial Risk Management Interventions in the Organic Agri-Food Chains

This study arises from the need to propose an alternative solution to existing hedging methods to all companies interested in hedging the price risk of raw materials. The research focuses mainly on the actors of the agri-food supply chains, in particular the organic sector, given the growing trend of the cultivation methodology and the need to protect entrepreneurs involved in short-chain spinneret who have less possibility of relieve higher costs incurred to ensure the sustainability of the product. However, our analysis envisages a customizable hedging method for any company that intends to protect itself from the price fluctuations of the commodity that represents the inherent nature of its business. The technique consists in the construction of specific contracts (in particular, derivative financial instruments) by investment banks or commercial banks oriented to the corporate segment that offer this service. Personalization is achieved by calibrating the constituent elements of the derivative on the basis of hedging needs. The parameterization is carried out by replicating the contractual specifications of the main futures on commodities listed on regulated markets. This will allow the creation of a combination of option contracts listed on the over-the-counter market in an overall strategy aimed at medium-long term hedging.

risk could also trigger that of price variation, as the contract goods, still to be delivered, could be sold to third parties at lower prices). In summary, all the risks inherent in a supply contract translate directly or indirectly into a price/credit risk. Among the various options available to farmers and other operators in the agri-food supply chains, that of hedging the risk of prices through futures and option contracts keeps one of the most interesting. Generally, the hedging activity is carried out between spot and futures prices of the same commodity (for example, spot price of soft wheat on the Bologna market and future price of soft wheat listed on the Euronext market). Another way of expressing this fundamental point is to define the hedging scheme as the exchange of price risk with base risk (difference between cash price and futures price). When the base is constant, the price movements are parallel and it is possible to offset the losses or gains on the position in the physical market with equal but opposite changes in the position in the futures market. In this research, however, hedging insurance coverage is provided through the use of the over-the-counter market by an investment bank, which acts as a "risk substitute" in the procurement of commodities, based on a new concept of financing the liquidity necessary for the transaction which allows not only to neutralize the price risk, but to participate in any profits, stabilizing company profitability and managing the risk of volatility. The options, therefore, help companies to protect the value of their investments and their products.

Objectives and Assumptions
This work is mainly aimed at studying the possible ways of managing price risk within the supply chain of the organic sector. Organic farming is by its very nature dedicated to attention to the environment and the productive ecosystem in which it operates. One might think that organic companies, being eco-sustainable and having no purchase costs for chemical products, have lower costs, but this is not the case. The yield of the crops and therefore of the resulting product is lower: following the climatic cycles, there is no certainty about the harvest and that everything grown is actually salable.
In organic farming, the risk of adverse climatic conditions and natural disasters also increases: the life time in contact with the soil increases considerably, the food is not harvested prematurely, and this involves greater risks; this means that most of the effort and gains can be lost. In the organic sector, the production cost is higher because there is a higher labor cost; transformation and distribution costs also have a greater impact. Therefore, every operator in the agro-bio sector is even more subject to the risk of price changes. The objective, therefore, is to allow organic farms to neutralize their exposure to upward or downward fluctuations in the commodity price, "freezing" the purchase conditions that it deems favorable at a precise moment and which will allow them to produce and sell the finished product without the risk of erosion of income margins.
In an economic framework such as the present one, characterized by a high volatility of market variables, the effective management of financial risks assumes strategic relevance for the company and can often translate into a competitive advantage. The research intends to support companies in identifying the nature of existing risks and in selecting the correct mix of solutions to mitigate the impact of these risks on business margins. The aims are the protection of the financial strength of the company, the protection of its profitability and the sustainable creation of value in a context of "controlled" risk. The supervision and management of the type of risk have a strategic value and the company must be able to expect on a bank that offers the possibility of minimizing it through solutions with a high rate of customization and diversification.
The phenomenon of the variability of cereal prices, in particular, has reached levels that are difficult to manage for the agricultural entrepreneur in recent years. The market is increasingly the victim of international speculations and the fluctuations in the prices of production have been added to the classic variables of uncertainty that govern the agricultural business: the meteorological trend, the quality and cost of technical means, the effectiveness of normal cultivation activities. To better explain these processes we will try to use some elements already disclosed in the theories of M. Friedman and the monetarists of the New Classical Macroeconomics (Lucas, Sargent, & Wallace). As has already been observed, agents no longer operate in a deterministic context, but rather in a stochastic environment, characterized by continuous random exogenous shocks: prices are flexible, supply presents characteristics of rigidity and there is the formation of short-term equilibria; however, this equilibrium is not necessarily fully employed precisely because it is influenced by shocks (of supply or demand, monetary or real): the existence of shocks causes the supply and demand curves to shift continuously over time with respect to their natural location, whereby prices are disturbed by the "normal" equilibrium position (i.e., the long-term position); agents must in fact make choices conditioned by perceived market signals and available information. Each balance is the result of choices made in the presence of imperfect and asymmetrical information. Nonetheless, the information is not sufficient, since it is based on past data to formulate hypotheses on future trends. For farmers, the ability to manage risk is therefore limited to adhering to contractual forms managed by industry. In general, we try to "fix" the price today. To do this, the canonical methods are: purchase on the physical market; the forward purchase or sale (forward) or the use of Futures; the purchase or sale of options. The first case is the classic one: if you need a certain quantity of wheat for a certain future date, you buy it today or as soon as the market price is considered appropriate, and so the price is fixed. This strategy avoids the risk of a price increase in the timeframe from the purchase date to the expiry but does not protect against the inverse risk, the fall in price over the same period of time. prices. The objective will be achieved mainly through the use of GOAL-Graphical Option Analysis® web application. In the context of project finance and, in this case, the function of constructing derivative contracts, complex strategies are created ad hoc, based on the specific needs of the companies that face the above risks. Many years of experience on the financial markets and the availability of privileged information are certainly of primary necessity, characteristics that only professionals and consultants in the sector possess.
The financial sector has developed new products that allow institutions and businesses to invest in commodities through long-term index funds, Over-the-Counter (OTC) swap agreements, exchange-traded funds and other structured products. These instruments have a common goal: to provide investors with buy-side exposure to the returns of a given commodity price index. The GSCITM (Standard's and Poor "Goldman Sachs Commodity Index") is one of the most widely used indices, and is generally considered an industry benchmark. This index is calculated as the production weighted average of the prices of 24 markets forward on commodities. Although the index is well diversified in terms of the number of markets and sectors, the weighting of production translates into a weight of the energy sector of 19.29% for the traditional agricultural sector (source: S&P Dow Jones Indices: S&P GSCI Methodology, June 2021) But most financial institutions and clients would find it difficult to purchase futures contracts to an extent that mimics an index (essentially, due to the enormous cash needed to maintain positions on the market). Alternatively, a company can ask an investment bank to structure a derivative for hedging purposes, in order to compensate for the volatility of some cost components of the production process: first of all, the variability of the price of the commodity object of its activities. For simplicity, we assume at the moment that the transaction does not provide for either gains or losses, but only the sterilization of the price risk. The merchant bank, therefore, estimates the mutability of the price in the future period, plus any margin. Therefore a "protection contract" is stipulated, the Commodity Future, with a strong customization component to meet the specific needs of the customer, and regulated at precise deadlines. An initial margin is paid: in particular, the initial guarantee margin is required to cover the theoretical liquidation costs that, in the event of insolvency, should be incurred to close the operator's positions. The amount of the initial margin does not correspond to the value of the position (another advantage of the futures contract) but only to a part of it: the one that is adequate to cover the cost of liquidating the portfolio in the most unfavorable market scenario reasonably possible. An analysis of the possible derivative instruments suitable to constitute the derivative strategies that will obtain their exposure in the OTC market continues. At the basis of this decision there is always a forecast estimate regarding the evolution of the economic quantities linked to the underlying in the period between the trading date and the expiry date.
In turn, the bank will enter the market by taking the positions analyzed. Since the payoff of structured derivatives (indexed to the commodity of reference) will change the day after the start of the protection contract, the payment of a maintenance margin (Mark to Market) is also envisaged on the basis of which the party that has lost deposits the differential to the other. In this way, the risk of default is mitigated and the regularity of the settlement is continuously ensured. From this we can immediately deduce the advantage of lower capital use, a factor that contributes to better business planning and the reduction of the volatility of the company's characteristic results.

Materials and Methods
It is now clear that, with a view to prudent and responsible conduct of the company, management can mitigate the risks of fluctuations in commodity prices through transactions in derivative financial instruments. The structured finance offices of the corporate banks have defined specific risk management policies that provide for the use of derivatives normally used in commercial practice. In this regard, the study aims to offer a method that constitutes an advantage for both contracting parties, so that banks are able to assist their production company customers with derivative products aimed at supporting the strategic paths of the company, elaborating innovative specialist solutions. Extensive reference has already been made to commodity derivatives, contracts that can be adapted to the specific needs of the company for hedging the risks of fluctuations in the prices of raw materials. However, it must be kept in mind that this product is aimed at customers who: have an adequate level of knowledge and experience to understand the characteristics of the product; need to carry out operations to hedge the financial risks associated with their economic activity; have a time horizon not exceeding the duration of the financial risk to be covered; have a risk tolerance compatible with the riskiness of the product intended for coverage. Contract design then becomes a combination of what is economically and technically feasible, knowledge of client's preferences and investment opportunities. This paradigm requires operators to develop an understanding of the objectives of potential users and place targeted and specific contracts on the market to meet heterogeneous needs. In this context, customization can represent the most suitable solution.
In addition to the standardized derivative instruments commonly traded on the futures markets, it is also possible to enter into numerous specific, non-standardized and non-negotiable contracts on the financial markets. However, these contracts can be negotiated on particular markets, called OTC, Over-the-Counter, through appropriate procedures that are often not formalized. The obvious advantage of this type of contract is the possibility that operators have to limit trading uncertainty due to price fluctuations even for those commodities that are not commonly traded on the financial markets. The valuation methodology provides for the identification of a commodity benchmark that can approximate the price of the underlying subject of the specific contract, applying the spread between the value of the contract and that of the commodity that acts as a benchmark on the date of signing the contract. Both elements have the same maturity with spread measured between the start date of the contract and the valuation date. The price of the commodity is fixed by choosing strike prices deemed suitable and convenient for company management. This will then be the element that at the future date will determine the convenience of the entire procedure. The applied model estimates the market value of the protection contract reflecting the counterparty risk.
As anticipated, the implementation and evaluation of the best risk management strategies will be carried out with GOAL (Graphical Option Analysis) web application accessible at: https://goal.ago-goal.it/. This financial software allows you to assess the risk of investing in derivative instruments with the aid of highly customizable graphic representations of the payoffs as the prices of the underlying contracts vary, processing the characteristic elements of the market. It is therefore possible to prepare hedging and correction portfolios or speculative strategies in order to estimate the payoff trend at several dates selected by the user at the same time and at different volatility values, by plotting the Profit & Loss curves and a series of linear combinations of them, selected by the user.
With GOAL® in this work will be carried out the construction of the constituent elements of the contract, their parameterization on the specific needs of coverage, the simulation of market shocks and, above all, the selection of suitable hedging strategies. This is a process based on volatility, on expectations regarding the underlying asset, on the investor's risk bent and on the quantification of the expected payoff. The critical issues to consider concern, first of all, the seasonality of the commodity.
In fact, to carry out a correct analysis of the wheat production and marketing chain in Italy it is necessary to describe the complex production storage system and the stipulation of specific contracts. It should be noted that the production cycle of the raw material in question is annual: at our latitudes it is possible to obtain only one production per year and the quantity is quite variable. Consumption, on the other hand, whether it is the production of semolina or hard flours, proceeds throughout the year, so that the constant supply is essential for modern industrialized mills. The sudden and wide fluctuations in commodity prices, the progressive growth of production costs and the structural dependence of raw materials from abroad highlight the criticalities in the functioning of the durum wheat supply chain.
With the use of GOAL®, a new type of contract is put in place to guarantee farmers the necessary tools to successfully face the cereals market by managing their risk from day to day activity in the short-medium term up to risk management long-term strategy.
It should be emphasized that there is no type of coverage valid for all categories of economic operator in the context to which we intend to refer; indeed, each operator in the supply chain, according to the type of activity it carries out, requires specific and appropriate coverage. Thus, in the case of the farmer, in order to define the optimal coverage ratio and evaluate its corresponding effectiveness, it is necessary to take into account both the periods of the year in which sowing and harvesting take place, and the length of the interval between these two periods (which vary according to the cultivation practiced and the climatic characteristics of the territory). In this sense, for the entrepreneurs of the agri-food supply chains, the covers have their own characteristic seasonality. The hedge can (and should) also be used by traders and industrial converters present along the supply chain, for two reasons: 1) the possession of raw materials does not give rise to the accrual of interest; 2) the possession of raw materials involves storage costs. It follows that the holder of the goods will have to face: 1) costs of storage, conservation, custody and insurance of the goods; 2) deferred rather than immediate revenues, with consequent financing costs. The latter assumption can be represented with the following formula (N.C. Schofield, 2007):  (Myers & Thompson, 1989), defined as the share of futures contracts on cash transactions that maximizes the objective function relating to positions on the physical market (the actual quantitative of raw material covered by the contract) and on the over-the-counter market. The profit at time t of an agent taking positions on the two markets at time t-1 is given by: where q t-1 = Physical Market Position at Time t-1; p t = Price of the Goods at Time t; f = Quotation of the Futures for Some Maturity After t; b t-1 = short position, or Sales on the Futures Market. In the mean-variance framework, the agent will maximize a function of the mean and variance of the profit conditional on information X t-1 available at time t-1.

Case Study
Let's consider the case of Molino Zeta, a hypothetical Italian company that transforms wheat into flour and semolina, the main ingredients of pasta and bakery products. It should be noted that the operators of the bread-making wheat supply chain have different interests and objectives for risk management.
For example, in addition to the price risk, farmers also face the risk of yield, and have an interest in setting the price of wheat as high as possible. The milling and bakery industry, on the other hand, does not face a risk of yield, rather it can be susceptible to a supply risk in thin market phases and also faces the price risk. Its interest is to ensure supplies of a given quality at the lowest possible price. The enhancement of production rarely occurs at the time of delivery, both due to the farmers' willingness to "look for the moment" and therefore the best price, and to minimize the risk of strong fluctuations in the price for the stackers who will sell the goods in a very long period. Therefore, in fact, the producer on delivery no longer has the availability of the goods, but will know the price and will collect the sum only several months after delivery, signing a sales contract with a price to be determined. To avoid these problems that sellers and buyers of grain (or commodities, in general) face, the need for this work has arisen: the agricultural entrepreneur must take advantage of the best market conditions and, at the has an export capacity equal to 25% of turnover. The future challenge facing the Zeta industry is to increase export shares, especially in the United States. In its overall processing, the purchase of the basic commodity (wheat) affects the budget for 70%. The receipt of the raw material is concentrated in a single month. Hence the need for proper management of the entire purchasing phase, which requires large amounts of liquidity, especially considering the uncertainty about the volatility of the price of wheat over medium-long periods. Given this company presentation, taking into consideration the prices of the raw material we want to analyze, we should immediately make some clarifications: the price of wheat in general must be distinguished at least in durum and soft wheat, of national or foreign production. The identification of a reference price can be done on the basis of individual markets or on a national basis; on a time basis from weekly to monthly or yearly. Generally, the price recorded is the prevailing one, i.e. the price at which the greatest quantity of product is traded, and undergoes have will be as follows: € 242.50 * 5000 tons = Euro 1,212,500 (which is the cost of the entire purchase of the commodity on the physical market if it happened in May 2021). Molino Zeta then calls on the Corporate office of its bank, asking to start hedging operations for the aforementioned purpose.
The bank structures a protection contract consisting of a Commodity Futures and a Commodity Option contract using as commodity benchmark the underlying CHICAGO SRW WHEAT (ZW) listed on the Chicago Mercantile Exchange (CME) which has the following contractual specifications (source: https://www.cmegroup.com/markets/agriculture/grains/wheat.contractSpecs.html):      The evaluation at maturity of the overall payoff and of the single contribution given to it by each of the transactions is summarized in the following graph:

Figure 6. Overall Time Analysis-Wheat Protection Contract Strategy March, 22
Further, the same survey can be coordinated by assuming market shocks that affect the implied volatility, calculated on the Call and Put At-the-Money at that particular moment. In the payoff chart below, the following volatility changes have been assumed:

March, 22
From the more "asymmetrical" payoff curves compared to those in the previous image, it is evident that the variability of the strategy yield shows a higher degree of risk in the intermediate dates. Indeed, periods characterized by high volatility represent a bearish movement of trading (Mandelbrot, 1963) on the Over-the-Counter market, a sign that the contracts should be recalibrated by acting on the parameters that influence the price (and therefore the protective strategy as a whole).

Result
The protection contract presented in the case study gives the entrepreneur the certainty of having defined a safe value, regardless of market fluctuations. At the same time, the Entrepreneur will be able to participate in any increases in market prices and obtain the liquidity available before the expected date of delivery of the goods by the supplier. On the other hand, with the use of a DSS (Decision Support System) software such as the one used in this research, banks can know in advance the counterparty risks, make quick decisions taking into account company operations and related need for flexibility of intervention, which derives in particular from the volatility of the markets and the promptness of reaction required. A further advantage to support decisions is the ability to study the effects of price risk management operations on customers' balance sheets. Indeed, for financial instruments traded on OTC markets, characterized by a knock-out clause that provides for the termination of the contract when the instrument reaches a certain target rate, the valuation is carried out using fair value valuation models, as referred to in the 'OIC 32 "Derivative Financial Instruments" (Organismo Italiano di Contabilità, 2016). The use of protection contracts could provide a non-marginal contribution to reducing the variability of the economic results of operators in the cereal supply chain, especially in periods of strong market turbulence and for medium-long periods. It could be possible to plan the purchase of production factors at a good price, protected from speculation, and at the same time have the opportunity to participate in market rises. The use of tools with a high rate of customization would allow operators in the agri-food chain to cover themselves from unwanted variations, thus promoting better planning of the activities of the supply chain. In particular, producers can fix the price of crops that have not yet been sown or matured by hedging themselves against the risk of negative price changes, thus focusing on production management. Mills and industrial companies can stabilize the costs of raw materials by setting their margin in advance and optimizing production planning.

Discussion
Successful contract innovation is based on the assumption that goods are stockable, homogeneous, subject to large price fluctuations, with ample liquidity, an unlimited supply flow with low delivery costs and a futures market. Black (1986) defined a successful contract as one that keeps both the volume of trades and open interest constantly high, and concluded that the success of the contract derives from the size of the market, the volatility of the price, the ability to reduce the risk and liquidity costs (Black, 1986).
The current market requires greater professionalism than in the past: operators need the necessary skills to perfect the control techniques to ensure the best coverage of your investments on a daily basis. This constant work of research and analysis is made necessary by the awareness that even apparently negligible changes when they occur can lead to different evolutions and important conjunctions in the market (in a reasonable amount of time and in relation to other small changes). In any case, a risk management strategy requires a careful business analysis to decide if, what and how to cover: it is essential not only to know the source and the methods of manifestation in order to be able to manage it consistently with the company objectives, but also to formalize and share the process by which it is identified, managed and monitored.