OPTIMAL CHOICE OF FIXED AND VARIABLE INTEREST RATE LOANS FOR MIDWEST CROP-LIVESTOCK FARMS: IMPLICATIONS FOR AGRICULTURAL LENDERS
Abstract
The primary objective of this study was to evaluate the optimal choice between fixed and variable interest rate loans for midwest crop-livestock farms. To attain this objective, a prototype farm planning model was developed. The model includes selection of investments and choice of the amount and terms of borrowed funds. Representative midwest crop-livestock farming situations were simulated with fixed interest rate loans hedged with options on financial instruments, and fixed interest rate loans with a constant premium (similar to fixed-rate home mortgage loans). A multiperiod discrete stochastic programming method was developed to model commodity price, yield, interest rate, asset price and available credit uncertainties. The sequential stochastic model allowed the linkages between years, including capital accumulation and funds transfer, to be stochastic. The results of this study indicate that farmers would not use fixed interest rate debt hedged with options if they are required to pay the full cost of the options. It was estimated that a premium of 3.25 percentage points over the rate on variable interest loans would be the greatest premium at which it would optimal to use at least some fixed interest rate debt. It was also estimated, using a two-state option pricing model, that a premium of 5 percentage points would be required to cover the cost of hedging. Fixed interest loans with a constant premium such as those observed in home mortgage markets, were considered. The results indicate that at a premium of 2 percentage points, the premiums on home mortgage loans at the time of this study, it would not be optimal for farmers to use fixed interest rate debt. A premium of 1.5 percentage points was estimated to be the largest premium at which it would be optimal to use at least some fixed interest rate debt. However, with a premium of one percentage point or less fixed interest rate debt was found to be attractive enough such that no variable interest rate debt was chosen.
Degree
Ph.D.
Subject Area
Agricultural economics
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