Hedging Instruments & Strategies For A Volatilie Asset In An Inefficient Market

Abstract: This Bachelors thesis involves the creation of a market place for animal compound feed risk management, potential hedging instruments and applicable risk management strategies. The market place is a cross hedged portfolio of futures contracts that correlate with the price of animal compound feed in Sweden, defined as an index and referred to as Compound Feed Index. The thesis has been conducted in collaboration with Lantmännen ek.för Feed Division, the largest producer of animal compound feed in Sweden. The producer looks to expand its’ offering to clients, i.e. livestock farmers, by potentially offering risk management solutions. Volatility in commodity raw materials used to produce animal compound feed has increased vastly and thus also the price volatility of animal compound feed has increased. Animal compound feed is the largest expense in the livestock farming business and there are currently no risk management solutions available. Using future contracts with the same underlying commodities as are used to produce animal compound feed, we conclude that a Compound Feed Index can be created as a portfolio with a cash position and defined weights of each separate futures contract. Unfortunately, due to an inefficient market structure without transparent and observable market prices, the strength of the correlation and the hedging contribution is not sufficiently high to recommend the implementation of the Compound Feed Index. We hope that this study can provide an example for future studies that aim to solve similar difficulties. As the market for animal compound feed becomes more transparent it is likely that a Compound Feed Index such as presented in this paper would be of value.