Weather DerivativesResearch Paper (undergraduate) from the year 2006 in the subject Business economics - Investment and Finance, grade: 1,7, University of Applied Sciences Essen, course: Case study in the core subject International Management - Risk Management, language: English, abstract: The ability to hedge price risks of industrial and consumer goods is well-developed an widely used, but, for many customers and companies, a variance in the unit volume being caused by a unexpected weather situation can be as detrimental to the bottom line as unit price variation. In the past, market participants were exposed defencelessly to this risk, because "weather has been anything but predictable..." There was bundle of incidents in the late 90's which lead to the development of weather derivatives as a new, flexible instrument to mitigate risk resulting from weather: First, the changing world climate causes more often extreme weather situations such as El Nino. Weather catastrophes like the hurricanes Katrina and Rita in the USA, summer flood of 2002 and the desert summer of 2003 in Germany have been increasing the awareness of weather risks among the population and in the management of the companies. Unforeseen weather conditions may cause a decline in companies' earnings. It is likely to imagine, that, for example, a cold and rainy summer will lead to a plummeting consumption of ice cream. In times of an upward tending importance of the shareholder value approach, a professional and effective risk management is inalienable. Insurance policies can cover catastrophic damages, but derivatives are an efficient tool to face financial risks resulting from the weather and to stabilize earnings. Secondly, the worldwide markets are changing. Formerly strictly regulated markets show an ongoing trend of deregulation and therefore a development from monopolies to wholesale markets. Facing a new, competitive situation, companies have to realize, that it does not last to hedge the unit price of their go |
Common terms and phrases
adverse amount application Auer average Basically Black branch buyer calculated call option catastrophe caused Commodities companies complex considered contracts Correlation daily defined degree day depending determine difficulties distribution effects Ellithorpe energy European example exchange expected Figure floor Forward future heating hedge historical Hull impact important increasing individual industry influence institutions interest investment lead limited loss maturity date maximum means measured method mitigate offer operative option price paid parameters participants payment payout period position possible precipitation premium presentation probability problem profit protect put option rainy reason received reference resulting risk management Safari-Land Scholes short shows Simulation situation standardized steps stochastic strike price summer swaps temperature traded underlying asset valuation variables visited weather conditions weather derivatives weather risks wind winter
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Page 5 - Everybody talks about the weather, but nobody does anything about it.
Page 15 - An option contract gives the holder the right but not the obligation to buy (call option) or to sell (put option) an asset at a predetermined future time and price. This predetermined price is known as the strike price and the predetermined date is known as the expiration or maturity date. At the time of purchase, the buyer of an option contract pays an option price to the option writer.
Page 20 - ... intermediary) to exchange cash flows over a certain period of time. An interest rate swap involves one party agreeing to pay a fixed rate of interest on a notional principal to another party in return for a floating rate of interest on the same principal (the principal is usually not exchanged). A currency swap involves exchanging principal and interest payments in one currency for principal and interest in another currency (the principal amounts are usually specified and exchanged at the beginning...
Page 8 - The leveraged nature of derivatives makes them an ideal low cost product for managing a variety of different risks and the ability to take on a position based only on payment of a very small deposit makes them hugely attractive as a speculative vehicle".12 This speculative use has led to the huge losses of companies like Metallgesellschaft AG.
Page 7 - ... you can invest in or hedge anything from beans to bonds, cattle to crude, stocks to silver, gilts to gold, euros to yen and coffee to orange juice".10 Hence, by using derivatives, many market participants can manage their market, credit or other forms of risks.
Page 16 - An option is a security giving the right to buy or sell an asset, subject to certain conditions, within a specified period of time. An "American option" is one that can be exercised at any time up to the date the option expires.
Page 16 - The buyer of a call option is given the right to buy a fixed number of the underlying asset at the strike price.