1. This problem offers different scenarios in which some companies may have an interest to hedge their exposure to temperatures that are detrimental to their business. In answering the problem, it is useful to ask the question: Which scenario hurts the company, and how can it protect itself? a) A soft drink manufacturer probably sells more drinks when it is abnormally hot. She dislikes days at which it is abnormally cold because people are likely to drink less, and her business suffers. She will be interested in a cooling-degree-day futures contract because it will make payments when her usual business is slow. She hedges her business risk. b) A ski-resort operator may fear large losses if it is warmer than usual. It is detrimental to her business if it does not snow in the beginning of the season or if the snow is melting too fast at the end of the season. She will be interested in a heating-degree-day futures contract because it will make payments when her usual business suffers, thus compensating the losses. c) During the summer months, an electric utility company, such as one in the south of the United States, will sell a lot of energy during days of excessive heat because people will use their air conditioners, refrigerators, and fans more often, thus consuming a lot of energy and increasing profits for the utility company. In this scenario, the utility company will have less business during relatively colder days, and the cooling-degree-day futures offers a possibility to hedge such risk. Alternatively, we may think of a utility provider in the northeast during the winter months, a region where people use many additional electric heaters. This utility provider will make more money during unusually cold days and may be interested in a heating-degree-day contract because that contract pays off if the primary business suffers. d) An amusement park operator fears bad weather and cold days because people will abstain from going to the amusement park during cold days. She will buy a cooling-degree-day future to offset her losses from ticket sales with gains from the futures contract.

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