A Brief History of Derivatives
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Kiruthika Lecturers Department of Commerce K. The settlement value of these weather events is determined from a weather index, expressed as values of a weather variable measured at a stated location. Weather derivatives are financial instruments that can be used by organizations or individuals to reduce risk associated with adverse or unexpected weather conditions. Weather exerts a great influence on businesses such as producing energy and agriculture.
Weather Derivatives are important first exchange traded financial derivative in india to hedge against losses occurring from uncertain weather events and can help reduce the impact of adverse weather on a company's profitability.
This article aims at providing the concept, types, utilities, beneficiaries and its pragmatic scenario in India. The world's first exchange traded weather derivative began trading on September 22, at the Chicago Mercantile Exchange.
Weather derivatives are financial products that enable an organization to offset the financial risk due to a weather variable.
Farmers can also use weather derivatives to hedge against poor harvests caused by drought or frost. Weather Derivatives are unique in many ways. The primary being, there is no first exchange traded financial derivative in india underlying asset. The underlying asset is the weather.
The values of weather derivatives are calculated based on a weather index. A HDD is the difference between a baseline temperature and the average temperature for a day in winters.
A CDD is the difference between the average temperature for a day and a baseline temperature in summers. The baseline temperature is fixed; it is 65 o Fahrenheit in the U. S and 18 o Celsius in Europe. Only certain parties may be interested in trading a specific type of weather commodity based on their business structure.
Some of the common weather derivative products include - 1. Swaps are contracts where two parties agree to exchange their risks. This will produce a more stable cash flow first exchange traded financial derivative in india weather conditions are volatile. In simple terms, one party agrees to pay the other if the contracted index settles above a certain level, while the other agrees to first exchange traded financial derivative in india if the index settles below that level.
Swaps have no premium but provide protection from adverse weather in return for giving up some of the upside of a favorable season. Collar is similar to swap in that protection against adverse weather is provided in return for giving up some of the returns generated in favorable conditions. The difference is that the payments to and from the parties' takes place outside an upper and lower level. This allows revenues to fluctuate within a normal range of weather conditions but protects either party against extreme weather.
Put options or floors are contracts that compensate a buyer if a weather variable falls below a pre-determined level. This type of protection involves a premium being paid upfront.
It provides protection against adverse weather whilst allowing profits to be retained in a favourable period. Call option or Caps are first exchange traded financial derivative in india that compensate a buyer if a weather variable falls above a pre-determined level. This type of protection also involves a premium being paid upfront. It provides protection against adverse weather whilst allowing profits to be retained in a favorable period. To illustrate, a commercial air-field might buy a call option when the number of days that the average wind speed exceeds a certain level.
This would compensate the airfield for the loss of revenue during days when they had to stop flying. He is worried because of the expectations of unusually low rainfall in the state this year. He usually produces quintals of Wheat in his farm. But this year, he thinks the production will drop to 80 quintals. This means that the farmer fears losing Rs 20, this season due to poor rainfall. If the farmer had access to weather derivatives, he could have bought or sold depending on the future outlook for rainfall rain day futures contracts today and entered into an equal but opposite contract at a later date, making a profit on the transaction, thus offsetting the losses due to low volumes produced.
Apart from applying weather derivative as a measure of hedging risk against adverse weather conditions it can also be used as the mode of trading in derivatives. The most advantageous factor of weather derivatives is the fact that they can't be manipulated by any means like insider trading as the raining patterns are natural and beyond the scope of humans.
Current users of weather futures are primarily energy companies in energy-related businesses. However, there is growing awareness and signs of potential growth in the trading of weather futures among agricultural firms, restaurants first exchange traded financial derivative in india companies involved in first exchange traded financial derivative in india and travel. But in a vast country like India where agriculture is spread throughout the length and breadth of the country Mother Nature has a very important role to play.
The Indian agriculture is still dependent heavily on the south west monsoons. It still doesn't have a strong irrigation system to support its farmers. The south west monsoons play a very important role in the agriculture industry of India. Most part first exchange traded financial derivative in india India is dependent on the monsoons for a better crop yield.
Hence it is most likely that weather derivatives in India should have the monsoon or rainfall as their underlying. It is also based on the way that normal derivatives are traded on the exchange. Weather trading in India has a long way to go. First and foremost until and unless the bill is passed and trading is allowed on intangibles such as rain, weather trading will be a dream. Even if the bill is passed and weather is traded on the exchange a very strong infrastructure should be created so as to have a far reaching effect.
Farmers from every nook and cranny of the country should be able to hedge of their risks. This can be done with the help of the local Gram Panchayats and e-choupals. Farmers and traders should be given exposure and educated about the benefits of weather trading.
Weather Derivative still has not been introduced in the Indian Market. With the recent amendments to the Securities Contract Regulation Act, derivatives trading are allowed in commodities. It was banned till last year. But trading in weather derivatives is yet to receive a formal nod from the government. The bank is selling weather derivatives as an over-the-counter product to companies whose operations are significantly dependent on weather conditions.
ABN Amro Bank is exploring sales of weather derivatives and catastrophe bonds for the first time in the country. The bank is talking to companies in the beverage and cement sectors, to airlines and oil majors to get them interested in the product. With a wide scope for weather derivatives in India, a number of trading firms are expected to offer customized weather derivative products, and lot more industries are expected to be covered in this net.
A farmer's common complaint "Everybody talks about the weather, but nobody does anything about it" will soon become a thing of the past with weather derivatives. Weather derivatives like any other exchange traded instrument can first exchange traded financial derivative in india the purpose of its creation only if it increases in volume and is in demand.
Instruments which work in one country may pass or fail in another region. But from the empirical studies conducted in other developing countries and with the success of weather derivatives their, India seems to have the potential to have a weather derivatives market. The key challenge is to educate the farmers about such contracts and their usage. The knowledge of derivatives in itself is limited to certain segments of the society, leave alone the weather derivatives.
In spite of the challenges, it is time the Government speeded up the process of launching weather derivatives in India too. A Need for Indian Farmers. E-mail April 29,