An Application of Risk Contingent Credit Applied to New York Dairy Farms with U.S. Options on Class III Milk Futures

Abstract

This paper addresses the financial risks faced by New York dairy farmers by discussing and developing prescriptive risk-contingent operating and mortgage loan contracts. It is argued that structured credit products with an imbedded contingent claim or price put option can effectively reduce or eliminate financial risks by providing payouts that reduce the amount of principal and/or interest that the farmer must repay under low price states. Formulas for risk-contingent operating and mortgage loans are developed and simulated.

Keywords: Risk-Contingent Credit, Contingent Claims, Agricultural Finance, Class III Milk Options

JEL Classification: G13, G21, G32, Q12, Q14