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Options, Futures, and Other Derivatives

John C. Hull

Chapter 35

Energy and commodity derivatives - all with Video Answers

Educators


Chapter Questions

01:52

Problem 1

What is meant by HDD and CDD?

Adam Conner
Adam Conner
Numerade Educator
02:27

Problem 2

How is a typical natural gas forward contract structured?

Mihir Nayar
Mihir Nayar
Numerade Educator

Problem 3

Distinguish between the historical data and the risk-neutral approach to valuing a derivative. Under what circumstance do they give the same answer?

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Problem 4

Suppose that each day during July the minimum temperature is $68^{\circ}$ Fahrenheit and the maximum temperature is $82^{\circ}$ Fahrenheit. What is the payoff from a call option on the cumulative CDD during July with a strike of 250 and a payment rate of $\$ 5,000$ per degree-day?

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Problem 5

Why is the price of electricity more volatile than that of other energy sources?

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06:02

Problem 6

Why is the historical data approach appropriate for pricing a weather derivatives contract and a CAT bond?

Shivani Sharma
Shivani Sharma
Numerade Educator
01:00

Problem 7

"HDD and CDD can be regarded as payoffs from options on temperature." Explain this statement.

Niamat Khuda
Niamat Khuda
Numerade Educator
00:49

Problem 8

Suppose that you have 50 years of temperature data at your disposal. Explain carefully the analyses you would carry out to value a forward contract on the cumulative CDD for a particular month.

Erika Bustos
Erika Bustos
Numerade Educator

Problem 9

Would you expect the volatility of the 1-year forward price of oil to be greater than or less than the volatility of the spot price? Explain your answer.

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02:04

Problem 10

What are the characteristics of an energy source where the price has a very high volatility and a very high rate of mean reversion? Give an example of such an energy source.

Karan Soni
Karan Soni
Numerade Educator

Problem 11

How can an energy producer use derivatives markets to hedge risks?

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Problem 12

Explain how a $5 \times 8$ option contract for May 2017 on electricity with daily exercise works. Explain how a $5 \times 8$ option contract for May 2017 on electricity with monthly exercise works. Which is worth more?

Rashmi Sinha
Rashmi Sinha
Numerade Educator
00:50

Problem 13

Explain how CAT bonds work.

Sam Limsuwannarot
Sam Limsuwannarot
Numerade Educator

Problem 14

Consider two bonds that have the same coupon, time to maturity, and price. One is a B-rated corporate bond. The other is a CAT bond. An analysis based on historical data shows that the expected losses on the two bonds as a function of time are the same. Which bond would you advise a portfolio manager to buy and why?

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Problem 15

Consider a commodity with constant volatility $\sigma$ and an expected growth rate that is a function solely of time. Show that, in the traditional risk-neutral world,
$$\ln S_T \sim \phi\left[\ln F(T)-\frac{1}{2} \sigma^2 T, \sigma^2 T\right]$$
where $S_T$ is the value of the commodity at time $T, F(t)$ is the futures price at time 0 for a contract maturing at time $t$, and $\phi(m, v)$ is a normal distribution with mean $m$ and variance $t$.

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13:09

Problem 16

An insurance company's losses of a particular type are to a reasonable approximation normally distributed with a mean of $$\$ 150$$ million and a standard deviation of $$\$ 50$$ million. (Assume no difference between losses in a risk-neutral world and losses in the real world.) The 1-year risk-free rate is $5 \%$. Estimate the cost of the following:
(a) A contract that will pay in 1 year's time $60 \%$ of the insurance company's losses on a pro rata basis
(b) A contract that pays $$\$ 100$$ million in 1 year's time if losses exceed $$\$ 200$$ million.

Arulmozhi T
Arulmozhi T
Numerade Educator

Problem 17

How is the tree in Figure 35.2 modified if the 1- and 2-year futures prices are $$\$ 21$$ and $$\$ 22$$ instead of $$\$ 22$$ and $$\$ 23$$, respectively. How does this affect the value of the American option in Example 35.3.

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