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Weather-Protection Products Could Take on Several Structures

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Weather-protection products could take on several structures:9

A floor provided the customer with downside protection when the underlyinG variable,

such as deGree-days, fell below the established threshold. The upside opportunity

remained unconstrained. The payout for the floor was equal to the deGree-day differential

times a $/dd. Most sellers of weather derivatives, however, were unwillinG to accept all

the downside risk associated with a floor and therefore set a payout limit.

A ceiling cap provided the customer with compensation if the underlyinG weather

variable went above a predetermined level. The seller of the ceilinG cap paid this

compensation to the buyer. A midwestern state miGht buy a snowfall ceilinG cap that

would compensate it if snowfall exceeded a certain level—--this payment would help to

reimburse the state for excessive snow-removal expenses. Temperature ceilinG caps could

be stated in deGree-days or payout limits.

A collar was a two-part transaction in which a customer bouGht a cap or a floor to

provide financial protection aGainst adverse weather conditions and simultaneously sold a

floor or a cap at a different strike price that limited its financial upside if weather were

favorable. The second part (the sale) helped to finance the first part (the purchase of the


A swap allowed the customer to Generate a fixed revenue stream. If actual deGree-days

were less (Greater) than the threshold, the utility received a payment equal to the deGree-

day differential times an aGreed-upon price per deGree-day ($/dd). If actual deGree-days

were Greater (less) than the threshold, the utility paid the seller. A swap was Generally

similar to the collar in its economic effect, except that it offered a sinGle triGGer level,

whereas the collar offered two. For instance, a utility miGht enter into a 30-day HDD

swap with a reference temperature of 65o Fahrenheit. If the actual averaGe temperature

turned out to be 55o, the utility was due 300 deGree-days (30 × [65



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