'Enron Weather Derivatives Case Summary Essay\r'

'Pacific northwestward Electric was a signifi batht producer of voltaic power. Seasons be a big deal to electricity companies: the colder the brave, the more electricity consumers use to power their heating. sounding back the last few years, CFO bloody shame Watts (an incredible electricity pun!) not frostingd a tr end up of relatively warm overwinters which in turn back resulted in less-than-optimal financial results. Though the 1990’s are remembered as a time of a profound economy, PNW suffered from a stagnant earnings-per-share growth during this period.\r\nAfter receiving a report of yet another warmer winter coming, Watts turned to a product offered by Enron tidy sum that claimed to minimize weather-related volume risk. There are some(prenominal) reasons derivatives could help PNW’s exposure to weather risk. For example, on a much smaller scale ice cream stores often go out of task because though summer gross revenue are great, managers do not know how to take out loans and damages to keep paying employees and other expenses during the off-season.\r\nPNW works the reverse gear way, with less demand in the summer, but the prejudice of demand in the winter months could be equilibrize for by using the derivatives product and smoothing revenue. The risk of stock-outs and lost-opportunity cost could be dodged. The derivatives could also help stimulate sales and overall diversify investment portfolios with correlation between weather and return, whereas futures were only being used to hedge against price risk by agreeing to deliver or accept a commodity at a certain time and price.\r\nThe way the product worked is that PNW would be able to determine how much margin it would discharge if the weather, measured by temperature, differed from the average readings in their geographic location. How much risk tolerance as cold as planned income loss from weather could be set up by the guild. In the end, the go with would receive a pay ment to offset lost income from reduced demand if the result was on a lower floor the accredited threshold. This would be called a floor, because the variable fell below the threshold though upper potential was until now available.\r\nOther structures could be a ceiling cap that compensates if variable goes above or a prehend which combines attributes of both the floor and ceiling cap and can be great when it essentially. funds the purchase of insurance. A swap can produce similar results, object for its actions are triggered singularly whereas the collar relies on ii separate tools. It is important to note that weather derivatives would not be included under an accounting conventionality that pertained to hedges under a market index sort of than customized contracts.\r\nWatts took into consideration correlation and geographic differences to realize that PNW call for protection from weather risk. Contracts she would approve to enter into with Enron would supplicate an init ial payment for entry, but would mean the company would receive a one-time payment at the end that adjusted to weather results and agreed tolerance levels. Whether or not the premium is worth it depends on the weather which has experienced a bad historical thin out but in the end is quite unpredictable. The close for a conservative company to enter this phase of contract is one that requires thought, but the largest focus should be setting threshold levels.\r\n'