NCCC-134
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Price Discovery for Stocker Cattle Futures and Options
Matthew A. Diersen and Nicole L. Klein
Year: 2000
 

Abstract

Low trading volume in the CME stocker cattle contracts has made hedgers and speculators reluctant to use the contracts. Traders need decision tools to discover prices or to evaluate quoted prices that may not contain all the information in the market. The number of head of stocker weight cattle sold on the spot market has increased in recent years while the practice of cross-hedging stocker weight cattle against the feeder cattle contract remains risky. A model explains the spread between feeder cattle and stocker cattle futures prices as a function of feed prices, live cattle prices, and seasonal factors. The volatility of spot stocker cattle prices is comparable to spot feeder cattle prices, supporting the idea of using feeder cattle implied volatility measures as estimates of stocker cattle futures implied volatility in option pricing models. The model and relations proposed should be useful for traders evaluating observed prices or placing limit orders for stocker futures and options. Key words: stocker cattle, cross-hedging, volatility, limit order, thin markets.

 
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Hedging with Futures and Options: A Demand Systems Approach
Darren L. Frenchette
Year: 2000
 

Abstract

The optimal hedging portfolio is shown to include both futures and options under a variety of circumstances when the marginal cost of hedging is non-zero. Futures and options are treated as substitute goods, and properties of the resulting hedging demand system are explained. The overall optimal hedge ratio is shown to increase when the marginal cost of trading options is reduced. The overall optimal hedge ratio is shown to decrease when the marginal cost of trading futures is decreased. The implication is that hedging demand can be stimulated by reducing the perceived cost of trading options, by educating hedgers about options and by initiating programs like the Dairy Options Pilot Program. The demand systems approach is applied to estimate optimal hedge ratios for dairy producers hedging corn inputs in five regions of Pennsylvania. Keywords: Hedging, Options, Futures

 
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Short-run Demand Relationships in the U.S. Fats and Oils Complex
Barry K. Goddwin, Daniel Harper, and Randy Schnepf
Year: 2000
 

Abstract

Fats and oils play a prominent role in U.S. dietary patterns. Recent concerns over the negative health consequences associated with fats and oils have led many to suspect structural change in demand conditions. We consider short run (monthly) demand relationships for edible fats and oils. In that monthly quantities of fats and oils are likely to be relatively fixed, we utilize an inverse AIDS specification. Our analysis consists of two components. In the first, we utilize a smooth transition function to model a switching inverse almost ideal demand system (IAIDS) that assesses short-run demand conditions for edible fats and oils in the U.S. Our results suggest that short-run demand conditions for fats and oils experienced a rather rapid structural shift in the early 1990s. Although this shift generally made price flexibilities more elastic, differences in flexibilities across regimes are modest in most cases. Our results suggest that decreases in marginal valuations for most fats and oils in response to consumption increases are rather small. Scale flexibilities are relatively close to -1, suggesting near homothetic preferences for fats and oils. An important distinction occurs for lard and tallow, which exhibit a very elastic scale response. This suggests that scale increases in the consumption of edible fats and oils will significantly decrease consumers' marginal valuation of these animal fats. A second segment of our analysis considers dynamic extensions to the IAIDS model that recognize habit effects. Although nested hypothesis testing supports the dynamic specification over the static IAIDS model, price and scale flexibilities are quite similar to the static case.

 
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Impact of alternative Grid Pricing Structures on Cattle Marketing Decisions
Heather C. Greer and James N. Trapp
Year: 2000
 

Abstract

Quality grade, yield grade, and other feedlot performance factors explain much of the variation in profit under grid pricing. Thus, feedlot owners can change profits by adjusting time on feed to influence these performance factors. This research uses growth models, logistic regression, and an optimization process to determine how the optimal number of days on feed changes under different grid pricing structures. It was found that large quality or small yield discounts increases the optimal number of days on feed and small quality or large yield discounts result in fewer days on feed. Losses associated with a grid having large quality discounts are minimized as cattle fed for more days are able to obtain Choice premiums despite the discounts for more Yield Grade 4 and 5 carcasses. Given small quality discounts, cattle fed for a shorter length of time can obtain the Yield Grade 1 and 2 premiums without a large loss in revenue due to grading Select or Standard. Under cash pricing, cattle are fed for very long periods because there are no discounts applied to the carcasses and, therefore, the more weight they gain, the more revenue they generate. During periods of low feed prices, cattle can be fed longer so more cattle grade Prime but also have more Yield Grade 4 and 5 cattle. Keywords: grid pricing, profits, animal growth, logistic regression, days on feed.

 
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Price and Price Risk Dynamics in Barge and Ocean Freight Markets and the Effects on Commodity Trading
Michael S. Haigh and Henry L. Bryant
Year: 2000
 

Abstract

The effects of volatility of barge and ocean freight prices on prices throughout the international grain-marketing channel are analyzed using a Multivariate GARCH-M model. The model is used to infer the extent to which transportation price risk affects the level of international grain prices. Results indicate that both barge and ocean price volatility influence grain prices, but barge price volatility tends to have a greater impact on grain prices than that arising from ocean price volatility. The lack of a futures contract for barge rates may be partially responsible for its significant influence on grain price levels. Keywords: Barge and ocean freight prices: futures contracts: Multivariate GARCH-Models: price volatility

 
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Increasing the Accuracy of Option Pricing by Using Implied Parameters Related to Higher Moments
Dasheng Ji and B. Wade Brorsen
Year: 2000
 

Abstract

The inaccuracy of the Black-Scholes formula arises from two aspects: the formula is for European options while most real option contracts are American; the formula is based on the assumption that underlying asset prices follow a lognormal distribution while in the real world asset prices cannot be described well by a lognormal distribution. We develop an American option pricing model that allows non-normality. The theoretical basis of the model is Gaussian quadrature and dynamic programming. The usual binomial and trinomial models are special cases. We use the Jarrow-Rudd formula and the relaxed binomial and trinomial tree models to imply the parameters related to the higher moments. The results demonstrate that using implied parameters related to the higher moments is more accurate than the restricted binomial and trinomial models that are commonly used. Keywords: option pricing, volatility smile, Edgeworth series, Gaussian Quadrature, relaxed binomial and trinomial tree models

 
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The Performance of Agricultural market Advisory Services in Marketing Wheat
Mark A. Jirik, Scott H. Irwin, Darrel L. Good, Thomas E. Jackson, and Joao Martines-Filho
Year: 2000
 

Abstract

The purpose of this paper is to investigate the performance of agricultural market advisory services in marketing wheat. Two key performance questions are addressed: 1) Do market advisory services, on average, outperform an appropriate wheat market benchmark? and 2) Do market advisory services exhibit persistence in their wheat performance from year-to-year? Market advisory service recommendations for wheat are available from the AgMAS Project for the 1995, 1996, 1997 and 1998 marketing years. At least 20 advisory programs are included for each year. Tests of pricing performance relative to a market benchmark are based on the proportion of programs exceeding the benchmark price and the average percentage difference between the net price of advisory programs and the benchmark price. In statistical terms, the pricing performance test results are clear. Not only do market advisory programs in wheat consistently fail to “beat the market,” their performance is significantly worse than the market. The level of under-performance is striking and consistent, with the proportion of programs above market benchmarks for the four-year period ranging from 0.34 to 0.38. Estimates of the four-year average return relative to market benchmarks range from –9.61 to –10.48 percent. Tests of predictability are based on the correlation of performance measures for overlapping and non-overlapping adjacent marketing years. In general, the predictability results provide little evidence that future advisory program pricing performance can be usefully predicted from past performance. On average, correlations are positive for overlapping years (e.g. 1995 vs. 1996). However, correlations tend to be negative for non-overlapping years (e.g. 1995 vs. 1997), which implies that producers selecting top-performing programs based on a given year, and expecting them to continue to be top-performing funds, would actually experience just the opposite result. Keywords: wheat, market advisory service, benchmark, market efficiency, pricing performance, predictability

 
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Returns to Market Timing and Sorting of Fed Cattle
Stephen R. Koontz, Dana L. Hoag, Jodine L. Walker, and John R. Brethour
Year: 2000
 

Abstract

This research examines the returns to a cattle feeding operation that sorts animals prior to marketing using ultrasound technology. The returns to sorting are between $11 and $25 per head depending on the number of groups the pens in which cattle can be sorted. Sorting faces declining returns. These returns can also be viewed as the costs imposed by institutional constraints that limit co-mingling of cattle. Through sorting, cattle feeding operations are able to reduce meat quality discounts, increase meat quality premiums, increase beef carcass quality characteristics, more efficiently use feed resources, and increase profits.

 
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Effects of Meat Recalls on Futures Market Prices
Jayson L. Lusk and Ted C. Schroeder
Year: 2000
 

Abstract

The number of meat recalls has increased markedly in recent years. Meat recalls have the potential to adversely affect short run demand for meat because of the associated decline in consumer confidence. This research examines the impact of beef and pork recalls on nearby daily live cattle and lean hog futures market prices, respectively. Results indicate that medium sized beef and large pork recalls that are a serious health concern have a marginally negative impact on short-term live cattle and lean hog futures prices, respectively. However, results are not robust across recall size and severity. This research suggests that if there is any systematic significant change in beef and pork demand due to meat recalls, it likely occurs over an extended period of time and only in certain cases does it noticeably affect daily futures prices. Keywords: meat recalls, event study, meat demand

 
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U.S. Farm Policy and the Variability of Commodity Prices and Farm Revenues
Sergio H. Lence and Dermot J. Hayes
Year: 2000
 

Abstract

A dynamic three-commodity rational-expectations storage model is used to compare the impact of the Federal Agricultural Improvement and Reform (FAIR) Act of 1996 with a free-market policy, and with the agricultural policies that preceded the FAIR Act. Results support the hypothesis that the changes enacted by FAIR did not lead to permanent significant increases in the volatility of farm prices or revenues. An important finding is that the main economic impacts of the pre-FAIR scenario, relative to the free-market regime, were to transfer income to farmers and to substitute government storage for private storage in a way that did little to support prices or to stabilize farm incomes. Keywords: FAIR Act, price volatility, storage.

 
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Using Satellite Imagery in Kansas Crop Yield and Net Farm Income Forecasts
Heather D. Nivens, Terry L. Kastens, and Kevin C. Dhuyvetter
Year: 2000
 

Abstract

Remotely sensed data have been used in the past to predict crop yields. This research attempts to incorporate remotely sensed data into a net farm income projection model. Using in-sample regressions, satellite imagery appears to increase prediction accuracy in the time periods prior to USDA’s first crop production estimate for wheat and corn. Remotely sensed data improved model performance more in the western regions of the state than in the eastern regions. However, in a jackknife out-of-sample framework, the satellite imagery appeared to statistically improve only 8 of the 81 models (9 crop reporting districts by 9 forecasting horizons) estimated. Moreover, 41 of the 81 models were statistically better without the satellite imagery data. This indicates that perhaps the functional form of net farm income has not been well-specified since additional information should generally not cause a model to deteriorate. Keywords: net farm income, remote sensing, satellite imagery

 
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The Impact of the LDP on Corn and Soybean Basis in Missouri
Joe L. Parcell
Year: 2000
 

Abstract

This study analyzed the effect of the Loan Deficiency Payment (LDP) program, established under the Federal Agriculture Improvement Reform (FAIR) act of 199, on corn and soybean basis in Missouri. Using daily corn and soybean basis data between 1993 and 1999 for multiple locations in Missouri, and incorporating a variable for when the LDP was in effect during 1998 and 1999, empirical models examining factors affecting corn and soybean basis were estimated. Results indicate that the presence of the LDP program has not had a significant economic impact on corn or soybean basis during the 1998 to 1999 period. Furthermore, factors affecting corn and soybean basis varied by time within the marketing year. Keywords: Basis, LDP, Government Programs, Corn, Soybeans

 
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An Empirical Invertigation of Live Hog Demand
Joe L. Parcell, James Mintert, and Ron Plain
Year: 2000
 

Abstract

An inverse live hog demand model was estimated to analyze claims that the live hog own quantity demand flexibility's magnitude has increased in recent years. A second objective of this research was to estimate the impact changes in processing capacity utilization rates have on live hog prices. Iowa - Southern Minnesota barrow and gilt price was modeled as a function of average daily hog slaughter, a processing capacity utilization ratio, an index of processing and marketing costs, a retail demand shift index, pork cold storage stocks, and monthly binary variables. Results indicate that in recent years live hog prices have become more responsive to changes in hog slaughter. Additionally, changes in processing capacity utilization rates, at times, also have a relatively large impact on live hog prices. Finally, when the large live hog price decline that occurred during the fall of 1998 is examined, model results indicate that the accumulation of large pork cold storage stocks, the sharp increase in processor's capacity utilization rates, an increase in average dressed weight, and the increase in average daily hog slaughter all had a large negative effect on live hog prices. Keywords: Live Hog Demand, Structural Change, Capacity Utilization

 
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Implications of Deflating Commodity Prices for Time-series Analysis
Hikaru Hanawa Peterson and William G. Tomek
Year: 2000
 

Abstract

The choice of deflators of commodity prices can change the time-series properties of the original series. This is a specific application of the general phenomenon that various kinds of data transformations can create spurious cycles that did not exist in the original data. Different empirical models of expectations result from nominal and various deflated series that have distinct time-series properties, and these models, in turn, produce varying estimates of supply response and measures of price risk. The foregoing is illustrated by annual grain prices, monthly milk prices, and a milk supply analysis. Annual prices of corn and soybeans, for example, appear to vary around a constant mean, but when deflated by general price indexes such as the CPI, the deflated prices are autocorrelated around a declining deterministic trend and/or have a stochastic trend. The quasi-rational expectations hypotheses assumes that farmers base expectations on forecasts from time-series models, but forecasts of real prices, that ultimately become negative, are not rational. Keywords: deflating, time-series analysis, price expectations, price risk, supply analysis

 
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Does the CFTC Commitments of Traders Report Contain Useful Information?
Dwight R. Sanders and Keith Boris
Year: 2000
 

Abstract

The Commodity Futures Trading Commission’s Commitments of Traders data are examined. Non-commercial positions are thought to contain the least amount of measurement error. Although non-commercials comprise a relatively small percent of the tested markets’ open interest (10% to 22%), they have the most volatile net positions. The data demonstrates a statistically (positive) negative contemporaneous correlation between net positions held by (non) commercials and market returns. However, traders’ net positions do not lead (Granger cause) market returns. In fact, returns lead traders’ net positions. Positive returns result in an (increase) decrease in (non) commercials net positions the following week. The findings suggest that prior empirical results, which make assumptions about traders’ positions not changing over a reporting interval, may be biased toward reflecting the contemporaneous position-return correlations reported in this research. Keywords: Commitments of Traders, commercial traders, non-commercial traders, funds

 
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An Analysis of Factors Affecting the Regional Cotton Basis
V. Frederick Seamon and Kandice H. Kahl
Year: 2000
 

Abstract

Few empirical basis studies have examined the basis in multiple regions and few have concentrated on cotton. This paper addresses this topic, examining consumption market factors that affect the cotton basis in five U.S. cotton production regions. The seemingly unrelated regression results indicate that the following factors are significant in explaining the basis: total U.S. cotton stocks and the ratio of foreign cotton stocks to foreign mill use in the Southeast and North Delta regions; regional stocks, the opportunity cost of storage and the foreign stocks to use ratio in the West Texas region; and regional stocks, total U.S. stocks, the opportunity cost of storage, and the foreign stocks to use ratio in the Desert Southwest and San Joaquin Valley regions. All significant coefficients have the hypothesized signs except the coefficient for the opportunity cost of storage and the coefficient for the ratio of foreign stocks to foreign mill use in two regions. The results indicate that the cotton basis in different regions is typically affected by different factors. Keywords: cotton basis, futures markets

 
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Weighted Expected Utility Hedge Ratios
Darren Frechette and Jonathan W. Tuthill
Year: 2000
 

Abstract

We derive a new hedge ratio based on weighted expected utility. Weighted expected utility is a generalization of expected utility that permits non-linear probability weights. Generally speaking weighted expected utility hedge ratios are less than minimum variance hedge ratios and larger than expected utility hedge ratios. Keywords: Hedging, hedge ratio, weighted expected utility, Allais Paradox.

 
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The Effects of the Micro-market Structure on Illinois Elevator Spatial Corn Price Differentials
Benjamin P. Wenzel, Lowell Hill, and Philip Garcia
Year: 2000
 

Abstract

Corn price differentials among Illinois elevators can often exceed transportation costs. Using primary data, we examine the effects of micro-market structure variables on the differentials in bids prices offered by Illinois elevators. Our findings suggest the existence of a highly developed, responsive market of competing firms, operating in an industry that can be characterized by monopsonistic competition, and to some extent by seasonally induced market power. Local supply conditions, firm productive efficiency, and their operating practices influence price differentials. Further, firm type, final market destination of the grain, and period of the marketing year affect price differentials. Keywords: Market structure, Corn price differentials

 
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Rollover Hedging
B. Sam Yoon and B. Wade Brorsen
Year: 2000
 

Abstract

Both market advisors and researchers have often suggested rollover hedging as a way of increasing producer returns. This study tests whether rollover hedging can increase expected returns for producers. For rollover hedging to increase expected returns, futures prices must follow a mean-reverting process. Using both the return predictability test based on long-horizon regression and the variance ratio test, we find that mean reversion does not exist in futures prices for corn, wheat, soybeans, soybean oil and soybean meal. The findings are consistent with the weak form of market efficiency. The results of the study imply that rollover hedging should not be seriously considered as a marketing alternative. As long as the commodity markets are efficient, the efforts of producers to improve returns through market timing strategies will meet limited success over time. Keywords: Rollover hedging, mean reversion, market efficiency

 
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The Effects of Futures Trading by Large Hedge Funds and CTAS on Market Volatility
Bryce R. Holt and Scott H. Irwin
Year: 2000
 

Abstract

This study uses the newly available data from the CFTC to investigate the market impact of futures trading by large hedge funds and CTAs. Regression results show that there is a positive relationship between the trading volume of large hedge funds and CTAs and market volatility. However, a positive relationship between hedge fund and CTA trading volume and market volatility is consistent with either a private information or noise trader hypothesis. Three additional tests are conducted to distinguish between the private information hypothesis and the noise trader hypothesis. The first test consisted of identifying the noise component exhibited in return variances over different holding periods. The variance ratio tests provide little support for the noise trader hypothesis. The second test examined whether positive feedback trading characterized large hedge fund and CTA trading behavior. These results suggest that trading decisions by large hedge funds and CTAs, although influenced in small part by past price changes, are not driven by past price changes. The third test consists of estimating the profits and losses associated with the open interest positions of large hedge funds and CTAs. This test is based on the argument that speculative trading can only be destabilizing if speculators buy when prices are high and sell when prices are low, which in turn, implies that destabilizing speculators lose money. Across all thirteen markets, the profit for large hedge funds and CTAs is estimated to be just under $400 million. This implies that the trading decisions are likely based on valuable private information. Overall, the evidence presented in this study suggests trading by large hedge funds and CTAs is based on private fundamental information. These findings imply large hedge funds and CTAs benefit market efficiency by bringing valuable, fundamental information to the market through their trading. Keywords: hedge fund, commodity trading advisor, volatility, market efficiency, futures markets

 
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Delivery Options in Futures Contracts and Basis Behavior at Contract Maturity
Jana Hranaiova
Year: 2000
 

Abstract

This paper estimates values of the delivery options implicit in the CBOT corn futures contract. Joint values of the timing and location options are estimated for the years 1989-97. By interacting the effects of the two delivery options, a potentially more accurate estimates are obtained. Two models are presented that rely on different assumptions about the institutional setup of the delivery process. The first model approximates the discreteness of the three day delivery process, while the second model relies on an assumption of immediate delivery that is consistent with the existing literature on pricing options. Individual hedgers can use these models to help them make delivery decisions. When all the costs of delivery are incorporated, true value of the delivery options can be obtained analytically. This can then be used to determine possible mispricing in the market as well as optimality of delivering early or delaying delivery. The estimated option values are used to explain the variability of bases in the deliverable locations. This application is useful for the exchange in evaluating hedging performance of futures contracts with respect to the delivery options embedded in them. Keywords: delivery options, joint timing-location option, basis convergence

 
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Time-varying Multiproduct Hedge Ratio Estimation in the Soybean Complex: A Simplified Approach
Mark R. Manfredo, Philip Garcia, and Raymond M. Leuthold
Year: 2000
 

Abstract

In developing optimal hedge ratios for the soybean processing margin, many authors have illustrated the importance of considering the interactions between the cash and futures prices for soybeans, soybean oil, and soybean meal. Conditional as well as time-varying hedge ratios have been examined, but in the case of multiproduct time-varying hedge ratios, the difficulty in estimation has been found to often outweigh any improvement in hedging effectiveness. This research examines the hedging effectiveness of the Risk Metrics procedure for estimating a time-varying covariance matrix for developing optimal hedge ratios for the soybean processing margin. The Risk Metrics method allows for a time-varying covariance matrix while being considerably easier to implement than multivariate GARCH (MGARCH) procedures. The Risk Metrics procedure has been advocated for use in developing Value-at-Risk estimates. While it provided considerable out-of-sample improvement in hedging effectiveness relative to a constant correlation MGARCH procedure, the Risk Metrics method provided only minimal improvement over a naïve (1-to-1) hedging strategy. However, this research does illustrate the potential for the Risk Metrics methodology as a viable alternative to MGARCH procedures in a multiproduct hedging context.

 
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Impact Of Exports on the U.S. Beef Industry
Ed Van Eenoo, Everett Peterson, and Wayne Purcell
Year: 2000
 

Abstract

Policy and programmatic decisions dealing with beef exports require good information as to the impact of exports on the domestic beef industry. This paper utilizes a partial equilibrium model of the world beef market to assess the impacts on the U.S. beef sector of increases in real income in major beef importing countries, the impacts of changes in the prices of pork and poultry products, and the impacts of changes in the price of feedgrains. A one percent increase in real GDP in Canada, Japan, Mexico, and South Korea yielded a 1.6 percent increase in U.S. exports of high-quality beef. This increase in exports leads to approximately a 29.2 million pound increase U.S. beef production on a retail weight basis. The increase in export demand also yields an increase in beef prices of approximately $0.275 per cwt. on a $120 box of beef and $0.18 per cwt on a $70 fed steer. One percent increases in the prices of pork and poultry products yield a smaller 0.8 percent increase in U.S. beef exports, but also lead to a 1.5 percent increase in U.S. imports of low-quality beef. This is due to U.S. consumers viewing low-quality beef as a substitute for pork and poultry. Finally, a one percent increase in the price of feedgrains reduces U.S. beef exports by 0.4 percent. This is due to a reduction in U.S. beef production from the increased feeding costs.

 
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