Question

Heating degree-day and cooling degree-day futures contracts make payments based on whether the temperature is abnormally hot or cold. Explain why the following businesses might be interested in such a contract: Problems 21 a. Soft-drink manufacturers. b. Ski-resort operators. c. Electric utilities. d. Amusement park operators. 1.2 Suppose the businesses in the previous problem

Answer 1

Answer:

a. Soft-drink manufacturers.

• Soft drink manufacturers generally sell more during warm days, so they will be interested in reducing risks (hedging) against cold days.

b. Ski-resort operators.

• Ski-resort operators sell more during cold days (winter), but their sales are negatively affected by both abnormal warm weather or extremely harsh cold weather, so they will be interested in reducing risks (hedging) against abnormal winter weather.

c. Electric utilities.

• Electric utility companies benefit from both HDDs and CDDs, so the more frequent they are the better for them. They probably dislike mild weathers, but love extremes.

d. Amusement park operators.

• Similarly to soft drink manufacturers, amusement park operators sell more during warm days, so they will be interested in reducing risks (hedging) against cold days.

Explanation:

Companies rely heavily on certain weather conditions and need to reduce risk will hedge weather risk.

Heating Degree Day (HDD) basically measures the demand for energy needed to heat some place, e.g. any type of building. If the temperature is below 65°, then people start to request that a place is heated (heating system turned on).

Cooling Degree Day (HDD) is basically the opposite, measures the demand for energy needed to cool some place. If the temperature is above 65°, then people start to request that a place is cooled (air conditioner turned on).