Enron Case Study
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Finance 485
Questions for Enron Corporations Weather Derivatives case
NOTE: Please dont waste any time at all seeking factual information outside this case about Enron, PNW, or weather conditions in the Pacific Northwest. Be assured that these are dead-end activities. Everything needed to answer the questions is inside the case.
QUESTIONS:
Why do they call these contracts “derivatives?” What are the various ways in which they are option-like?
Draw a diagram of the exposure of PNWs value to heating degree days (HDD) before it institutes a hedge.
Draw a diagram of the payoffs at the end of the life of the contract presented in case Exhibit 1.
Draw a diagram of the exposure of PNW to HDD after it uses the hedging contract presented in case Exhibit 1.
1. These contracts are called derivatives because the value of the contracts are derived from the underlying which are the deviation of degree days. The various ways in which these are option-like is because of the conceptual aspect of exercising if the amount of degree days or a weather variable deviates enough from the neutral point. Its option like in that there is a strike amount and a theoretical current amount.
3. puts
Pro- protected against fluctuations in weather deviation
Protecting earnings from unseasonably warm weather
Guaranteed steady income
Protected against
Enron- premiums
No competitors with wath,
Large untapped market
Unregulated
Lower correlation between returns associated with weather, and returns from other financial instruments.
Extremely liquid- a lot of buyers
Deconstruct the options embedded in the contract given in case Exhibit 1. Are they puts or calls? Are the positions long or short from PNWs perspective?
What are the pros and cons of weather protection from PNWs perspective?
Why is Enron in this situation? How does Enron stand to gain?