Weather-Protection Products Could Take on Several Structures
Essay by people • September 3, 2011 • Essay • 504 Words (3 Pages) • 2,265 Views
Essay Preview: Weather-Protection Products Could Take on Several Structures
Weather-protection products could take on several structures:9
A floor provided the customer with downside protection when the underlyinG variable,
such as deGree-days, fell below the established threshold. The upside opportunity
remained unconstrained. The payout for the floor was equal to the deGree-day differential
times a $/dd. Most sellers of weather derivatives, however, were unwillinG to accept all
the downside risk associated with a floor and therefore set a payout limit.
A ceiling cap provided the customer with compensation if the underlyinG weather
variable went above a predetermined level. The seller of the ceilinG cap paid this
compensation to the buyer. A midwestern state miGht buy a snowfall ceilinG cap that
would compensate it if snowfall exceeded a certain level--this payment would help to
reimburse the state for excessive snow-removal expenses. Temperature ceilinG caps could
be stated in deGree-days or payout limits.
A collar was a two-part transaction in which a customer bouGht a cap or a floor to
provide financial protection aGainst adverse weather conditions and simultaneously sold a
floor or a cap at a different strike price that limited its financial upside if weather were
favorable. The second part (the sale) helped to finance the first part (the purchase of the
insurance).
A swap allowed the customer to Generate a fixed revenue stream. If actual deGree-days
were less (Greater) than the threshold, the utility received a payment equal to the deGree-
day differential times an aGreed-upon price per deGree-day ($/dd). If actual deGree-days
were Greater (less) than the threshold, the utility paid the seller. A swap was Generally
similar to the collar in its economic effect, except that it offered a sinGle triGGer level,
whereas the collar offered two. For instance, a utility miGht enter into a 30-day HDD
swap with a reference temperature of 65o Fahrenheit. If the actual averaGe temperature
turned out to be 55o, the utility was due 300 deGree-days (30 × [65
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