Solution Manual For Derivatives Markets, 3rd Edition

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Chapter 1Introduction to DerivativesQuestion1.1This problem offers different scenarios in which some companies may have an interest to hedgetheir exposure to temperatures that are detrimental to their business. In answering the problem, itis useful to ask the question: Which scenario hurts the company, and how can it protect itself?a)A soft drink manufacturer probably sells more drinks when it is abnormally hot. She dislikesdaysat which it is abnormally coldbecause people are likely to drink less, and her businesssuffers. She will be interested in a cooling-degree-day futures contractbecause it will makepayments when her usual business is slow. She hedges her business risk.b)A ski-resort operator may fear large losses if it is warmer than usual. It is detrimental to herbusiness if it does not snowin the beginning of the seasonor if the snow is melting too fast atthe end of the season. She will be interested in a heating-degree-day futures contractbecauseit will make payments when her usual business suffers, thus compensating the losses.c)During the summer months, an electric utility company, such as one in the south of theUnited States, will sell a lot of energy during days of excessive heatbecause people will usetheir air conditioners, refrigerators,and fans more often, thus consuming a lot of energy andincreasing profits for the utility company. In this scenario, the utility company will have lessbusiness during relatively colder days, and the cooling-degree-day futures offers a possibilityto hedge such risk.Alternatively, we may think of a utility provider in the northeast during the winter months, aregion where people use many additional electric heaters. This utility provider will makemore money during unusually cold daysand may be interested in a heating-degree-daycontractbecause that contract pays off if the primary business suffers.d)An amusement park operatorfears bad weather and cold daysbecause people will abstainfrom going to the amusement park during cold days. She will buy a cooling-degree-dayfutureto offset her losses from ticket sales with gains from the futures contract.Question1.2A variety of counterparties are imaginable. For one, we could think about speculators who havedifferences in opinion and who do not believe that we will have excessive temperature variationsduring the life of the futures contracts. Thus, they are willing to take the opposing side, receivinga payoff if the weather is stable.Alternatively, there may be opposing hedging needs: Compare the ski-resort operator and thesoftdrink manufacturer. The cooling-degree-day futures contract will pay off if the weather isrelativelymild, and we saw that the resort operator will buy the futures contract. The buyer of

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Derivatives Markets by Robert L. Mc...

Solution Manual For Derivatives Markets, 3rd Edition

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