Enron Corporation’s Weather Derivatives

Slides:

Advertisements

Similar presentations

© Zurich Re Weather Risk Management David Molyneux, FCAS.

Advertisements

FINANCIAL ENGINEERING: DERIVATIVES AND RISK MANAGEMENT (J. Wiley, 2001) K. Cuthbertson and D. Nitzsche Lecture Advanced Derivatives.

Financial Risk Management of Insurance Enterprises Interest Rate Caps/Floors.

Copyright  2005 by Thomson Learning, Inc. Chapter 18 Managing Financial Risk with Derivatives Order Order Sale Payment Sent Cash Placed Received Received.

Introduction to Derivatives and Risk Management Corporate Finance Dr. A. DeMaskey.

CHAPTER 18 Derivatives and Risk Management

© 2008 Pearson Education Canada13.1 Chapter 13 Hedging with Financial Derivatives.

Weather Derivatives Michaël Moreno *Speedwell is a member of the WRMA *Speedwell is regulated by the SFA.

THE WEATHER MARKET Rodney R. White University of Toronto.

HDD and CDD Option Pricing with Market Price of Weather Risk for Taiwan Hung-Hsi Huang Yung-Ming Shiu Pei-Syun Lin The Journal of Futures Markets Vol.

Chapter 9. Derivatives Futures Options Swaps Futures Options Swaps.

© Zurich Re Weather Risk Management David Molyneux, FCAS.

Risk and Derivatives Stephen Figlewski

Swaps An agreement between two parties to exchange a series of future cash flows. It’s a series of payments. At initiation, neither party pays any amount.

Introduction to Weather Derivatives By Anjelina Belakovskaia Weather Derivatives Trader Head of the Weather Desk at Williams Co. Copyright 2002 © Anjelina.

1 CHAPTER 23 Derivatives and Risk Management Risk management and stock value maximization. Derivative securities. Fundamentals of risk management. Using.

Derivatives and Risk Management

Professor XXXXX Course Name / # © 2007 Thomson South-Western Chapter 18 Options Basics.

Derivatives and Risk Management Chapter 18  Motives for Risk Management  Derivative Securities  Using Derivatives  Fundamentals of Risk Management.

MANAGING INTEREST RATE RISK. THEORIES OF INTEREST RATE DETERMINATION Expectation theory : –Forward interest rate are representative of expected future.

Chapter 10: Options Markets Tuesday March 22, 2011 By Josh Pickrell.

Derivative securities Fundamentals of risk management Using derivatives to reduce interest rate risk CHAPTER 18 Derivatives and Risk Management.

MAY 17, 2001 ENERGY MARKETS IN TURMOIL PRESENTED TO THE INSTITUTE FOR REGULATORY POLICY STUDIES

All Rights Reserved Dr David P Echevarria 1 INTEREST RATE DERIVATIVE MARKETS CHAPTER 15.

Financial Risk Management of Insurance Enterprises Options.

Credit, Weather, Energy, and Insurance Derivatives Chapter 20.

Update on the Natural Gas Situation: Terry H. Morlan Northwest Power Planning Council Power Committee Briefing July 16, 2003.

Analyzing Financial Statements

Derivatives and Risk Management Chapter 18  Motives for Risk Management  Derivative Securities  Using Derivatives  Fundamentals of Risk Management.

1 CHAPTER 4 DEVELOPING A BUSINESS PLAN: BUDGETING.

1 Chapter 23 Risk Management. 2 Topics in Chapter Risk management and stock value maximization. Fundamentals of risk management.

DERIVATIVES. Introduction Cash market strategies are limited Long (asset is expected to appreciate) Short (asset is expected to depreciate) Alternative.

Russian Trading System Stock Exchange How to work with weatherfutures? How to work with weather futures?

CHAPTER 18 Derivatives and Risk Management

CHAPTER 21 Option Valuation Investments Cover image Slides by

EXHIBIT 8–3 Trade-Off Diagrams for Financial Futures Contracts

Derivative Markets and Instruments

Interest Rate Options Kayla Sims.

Financial forecasting

Chapter 18 Option Valuation.

FINANCIAL DERIVATIVES/SNSCT/MBA

Chapter 30 – Interest Rate Derivatives

Weather, Energy, and Insurance Derivatives

Chapter 11. Trading Strategies with Options

CHAPTER 18 Derivatives and Risk Management

Financial Risk Management of Insurance Enterprises

and short term financial planning

Credit Default Swap (CDS) Basics

Options (Chapter 19).

Knowledge Organiser Effective Financial Management

Risk Management with Financial Derivatives

Uncertainty in forecasts

CHAPTER 23 Derivatives and Risk Management

Definition of Risk Variability of Possible Returns Or The Chance That The Outcome Will Not Be As Expected copyright anbirts.

Fintech Chapter 12: Options

The Basic Tools of Finance

The Basic Tools of Finance

CHAPTER 18 Derivatives and Risk Management

Risk Management with Financial Derivatives

Derivatives and Risk Management

Derivatives and Risk Management

Integrated Risk Management

Understanding Corporate-Value-At-Risk (C-VaR)

Credit Default Swaps at FAB Part 1:

The Basic Tools of Finance

Credit Default Swaps at FNB Part 1:

Dr Harvey Stern, Climate Manager, Victoria and

Presentation transcript:

Enron Corporation’s Weather Derivatives

Who is PNW and what problem is it facing? Pacific Northwest Electric Facing the 2000-2001 winter season Recent warmer-than-average winters Hurts revenues Deregulation doesn’t allow them to pass costs on to customers PNW’s stock has lagged benchmarks Borrowing costs increasing because lower rating

Example of how weather can affect a business adversely Too warm of winters reducing a utility’s revenues from less heating usage Too mild of summer reducing a utility’s revenues from less air conditioning usage Storms keeping shoppers indoors Lack of snow affecting ski resorts Too rainy / too cool summer affecting beach destinations Too hot of a summer might lead to too much demand of a product and stockouts might occur (turn people away)

How could weather insurance help? Smooth Revenues Cover Excess Costs Reimburse lost-opportunity costs Stimulate Sales Diversify investment portfolios

Some Utility lingo… Heating Degree Days (HDD) Cooling Degree Days (CDD) Based on deviations from 65 degrees Fahrenheit

Possible weather-protection products Floor (too warm of winter and HDDs fall) Ceiling Cap (too much snow – city expenses) Collar (long one contract, short another) Swap (receive fixed revenue stream; pay floating payments based on HDD/CDD) Futures Contract (cash settlement based on several airport temps)

The contract at hand… (Exhibit 1) Draw its payoff diagram (to PNW) $ Payoff 800,000 Max Payout $20,000 notional amount per HDD 800,000 / 20,000 = 40 400 – 40 = 360 is the HDD where they would cap out at. 800,000 360 400 HDDs

Pros and Cons of this contract Reduce Downside Risk Truly serious outcomes only partially covered Keep Stock Price Less Volatile Premium has to be paid Contribute to Better Bond Rating Reduce the cost of financing

Can Black-Scholes be used to price? No. Black-Scholes assumes a random walk in the price of the underlying asset over a period of time Here, we have a cumulative level as our underlying, so their “walk” through time is not random. It is based on prior days’ events. A simulation tool like Crystal Ball would have to be used to simulate possible payouts under a large number of trials. An expected payout would then be found and a premium set above that level. You need to look at a reasonably large sample of historical records to find the average HDDs and CDDs and their standard deviations. Then you need determine if there is a trend to consider.