Antony Ricci
1065663
MSM4G12

Topic: Describe and discuss Weather Derivatives.

Description and discussion:

Even in our advanced, technology-based society, we still live largely at the mercy of the weather. It influences our daily lives and choices, and has an enormous impact on corporate revenues. Until recently, there were very few financial tools offering companies protection against weather-related risks. However, the invention of the weather derivative has changed all this by making weather a tradable commodity.

Weather derivatives represent financial products those companies and other organizations can use as part of their risk management strategy, using these tools they can reduce risk associated with adverse or even unexpected weather conditions. The main difference from other derivatives lies in the fact in this case the underlying (rain, temperature or snow) has no direct value to price the weather derivative. Let present different examples to figure out how this product can be useful. Farmers can use weather derivatives to hedge against rainy weekends during peak summer seasons; and gas and power companies may use Heating Degree Days (HDD) or Cooling Degree Days (CDD) contracts to smooth earnings. A sport event managing company may wish to hedge the loss by entering into a weather derivative contract because if it rained the day of the sporting event, fewer tickets would be sold. In practice, these contracts pay out in cash if the weather hits a selected level of heat, cold, rain or drought.

What conclusions can be drawn from these examples: first we can already highlight the fact that weather derivatives target a wide and diversified range of companies. Not only they enable companies to hedge against poor weather, but also enable them to attract new customer by offering new products. We can take the example of a ski resort that want to propose a refundable season ticket in the event of insufficient snowfall over the season. Using weather