Explain how hdd and cdd are calculated

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Finance question -

Chapter 14 of your book discusses weather, energy, and insurance derivatives. You can also find additional information on the weather derivatives from CBOE web site (www.cboe.com) and CME group web site. Many companies are in a business where their financial performance is adversely affected by the weather and it makes sense for them to consider hedging their weather risk in much the same way they hedge currency or interest rate risks.

Q2. A typical weather call option provides a payoff to call buyer dependent on the cumulative Heating Degree Days (HDD) or Cooling Degree Days (CDD). The options are settled in cash.

(a) Explain how HDD and CDD are calculated.

(b) Assume that the exercise (strike) price for call option is 700 and cumulative HDD is 1050.  The dollar multiplier per degree day is \$10,000. What will be cash payoffs to call option buyer in this situation?

Q3. Since electricity cannot be stored, its price has been subject to 100%-200% volatility per annum. The CME Group trades electricity futures and there are also over-the-counter electricity options and forwards.

(a) Please list the likely major users of electricity futures, forwards, and options.

(b) How might Southern California Edison use electricity futures or options to protect or improve its financial performance? Explain. Limit your answer to ten sentences.

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