Review Energy Trading.
1) Other than price & quantity there are three common characteristics of any contract. Identify each of these three and discuss their relevance to valuation of commodities. Form: What exactly is being delivered, Cost of transformation: taking one form and transforming to another form. Riskless trade capturing the full cost of transformation. Space: Location for delivery of the contract, driver is the cost of transporting an asset from one point to another. Riskless trade is buying one location and selling another at the full cost of transportation. Time: When the contract is to be delivered. Is associated with the cost of carry – the dollar cost of storing an asset. 2) There are three major components of risk in commodity trading. Identify these three risks and discuss what they are and how each can be managed. Market Risk: It’s a combination of price risk( exists when a company makes or loses money as a result of changing prices), liquidity risk( being able to buy or sale the same commodities you want whenever you want without moving the market), and volume risk( ) This risk can be managed with financial instrument such as futures, forwards, options and swaps. Credit Risk: Is the risk of a loss due to a default on the contract from either a buyer or a seller. This risk can be managed with marking to market. Operational Risk: the risk of loss resulting from inadequate or failed internal processes, people and systems, or from external events.. Can be manage with taking care of the organizational structure, add technology and information. 3) A Cash/OTC/Forward/Bilateral market and its relevant futures market differ in three major aspects. Identify these three aspects and mechanical differences, if any, and discuss how they impact the user of those markets. Forward: Not standardize, highly tailored, default risk, Not liquid. Futures: Very standardize, not default risk, Very liquid.
4) In futures markets there is a specific...
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