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Research Bulletin (Iowa Agriculture and Home Economics Experiment Station)

Abstract

The Federal Intermediate Credit Banks through local Production Credit Associations and other financial institutions have become significant suppliers of non-real-estate credit to agricultural producers. The increased volume has been accompanied by fluctuations in the funding volume and costs at which the funds are obtained. The liability management model developed and empirically tested in this study is an operational procedure that may be useful to the banks as an aid in selecting liability structures that minimize the average cost of credit that they provide to PC As and OFIs.

The model requires an estimate of monthly expected debt costs for the Farm Credit System securities for a 18-month future period and quarterly estimates for an additional six quarters. It also requires an estimation of monthly and quarterly debt requirements for the 3-year future period. With these coefficients, the model generates an efficient frontier of debt portfolios for a 3-year period. That efficient frontier is structured so that a minimum expected-cost debt portfolio is derived for each level of cost variance. A movement to a lower expected-cost portfolio on the efficient frontier entails a higher level of cost variance. The model can be used to obtain a new efficient frontier when a change in projected expected debt costs (interest rate change) or debt requirements becomes evident. In most situations, the model would be used at least once a month when a decision to participate in a bond issue is made. The model also can be used to assess the impact of alternative debt policy constraints on cost and risk.

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