Energy Derivatives And Risk Management-Books Pdf

ENERGY DERIVATIVES AND RISK MANAGEMENT
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Table of contents, Abstract 4, Introduction 5, 1 Risk management. 1 1 A brief historical background 9, 1 2 Risk definition and measurement 10. 1 3 The risk in corporate finance 12, 1 4 The reasons for hedging 13. 1 5 The risk in capital investment 15, 1 6 From hedging to risk management 17. 2 Enterprise risk management, 2 1 Definition 19, 2 2 Implementation 20.
2 3 Case studies in literature 23, 2 4 Empirical observations 26. 2 5 Evolution of risk management 32, 3 The quantitative tools of risk management. 3 1 The Black Scholes model 35, 3 2 The main VaR methodologies 37. 3 2 1 The historical simulation 38, 3 2 2 The Variance covariance or analytical method 39. 3 2 3 The Monte Carlo method 41, 3 3 Alternatives to Value at risk 43.
4 Energy derivatives, 4 1 Markets for commodities 46. 4 2 Introduction to derivatives 49, 4 2 1 Forwards 50. 4 2 2 Futures 51, 4 2 3 Options 52, 4 2 4 Swaps 54. 4 3 Energy derivatives classification 55, 4 4 Energy forwards futures and swaps 55. 4 4 1 Energy forwards 56, 4 4 2 Energy futures 57, 4 4 3 Energy swaps 58.
4 5 Energy options 59, 4 6 Valuing energy derivatives 60. 4 7 Numerical techniques to value derivatives 63, 4 7 1 The trinomial method 64. 4 7 2 Monte Carlo simulation 65, 4 8 Techniques for hedging energy derivative positions 66. 5 Hedging against energy risk, 5 1 Methodology 70, 5 2 Oil hedging on NYMEX 73. 5 3 The case of MetallGesellSchaft 76, 5 4 The case of the airline industry 78.
5 5 Electricity hedging on NYMEX 81, 5 6 The case of the Nordic Power Exchange 83. 5 7 The case of the Texas electricity market 85, 5 8 Gas hedging with options 86. 5 9 Energy derivatives pros and cons 88, Conclusions 91. References 94, Web references 100, This thesis aims to provide an overview about the relevance of risk management. practises and energy derivatives for the energy companies. The energy sector characterized by a high degree of uncertainty is particularly. interesting to study this topic because its business is highly dependent on commodity. price risk exposure The research conducted in this work will be oriented to find out. how companies operating in this sector may deal with risk and the instruments. available to hedge against it, Energy derivatives will be regarded as the main hedging instruments but if on the one.
hand companies may take advantage from their use they can also become source of. volatility if they actually contribute to increase the exposure Thereby this thesis is. also committed to describe risk management systems and quantitative tools that. companies necessarily need to use in tandem with derivatives in order to control their. The goal will be that of showing the benefits that risk management may provide to. energy companies and under which conditions energy derivatives may be effective. hedging instruments, Introduction, Energy markets are a collection of commodities such as oil gas and electricity. differing in composition but all having in common a high degree of volatility A high. level of uncertainty strengthen by deregulation in most of energy markets comes. from the commodity price risk exposure related to the consequences that commodity. price fluctuations could cause to the companies operating in the energy sector both. from the offer and demand sides It is sufficient to imagine the consequences that an. oil shock would cause to the energy companies profits if they did not care about risk. Indeed despite their differences today s energy markets follow the same impulses. energy producers and users alike wish to hedge their exposure to future uncertainty. Pilipovic 1998, Given the magnitude of energy risk the energy sector becomes an interesting focus for. the aim of this thesis that is studying the use of risk management practises and in. particular of derivatives to hedge against risk This focus leads to discuss about a. particular kind of financial instruments used as hedging tools in the energy markets. that are the energy derivatives Energy forwards futures swaps and options their. combinations and the strategies built with them are the most intuitive tools applied. by the energy companies to hedge against energy risk Nonetheless they are only a. part of the risk management systems that many energy companies built to deal with. risk made by organizational practises risk culture risk department and CRO figures in. some cases as well as quantitative tools risk metrics to keep control of risk and to use. in tandem with energy derivatives In fact if on the one hand energy derivatives are. applied for a hedging purpose on the other hand they can lead to increase the. exposure if incorrectly used metrics like VaR need to be used as well to provide a. measure of the risk involved in an energy derivatives portfolio. Although they will be shown as useful financial instruments to take an opposite. position to that of the risk in the market so to mitigate it the role of derivatives in the. current crisis is widely documented Oldani 2012 As a result they need to be used in. an integrated risk management system within the enterprise. In order to discuss the above mentioned topics and to answer to a research question. requiring to illustrate the benefits of energy derivatives and risk management for the. companies operating in the energy sector this thesis follows a logical process spread. out five chapters, After this short introduction the beginning of the work in the first chapter is made of. a general definition of risk Risk definitions from literature applied to the enterprise. are provided to the reader because to deal with something it is essential to have a. knowledge about it Together with risk definitions the most known risk measures are. illustrated starting from the elementary variance and standard deviations to arrive to. the models linking risk to return such as CAPM APT and Fama and French models. Then the role of risk in corporate finance and capital investment is treated as well. The analysis of risk from different points of views is necessary to introduce the reasons. why firms hedge Moreover a paragraph is devoted to the shift from hedging to risk. management made essential by the volatility of some businesses like the energy. one where risk may be perceived not only as a threat but also as an opportunity. Damodaran 2007 This last step is ad hoc to forecast the topic of the second chapter. The second chapter is about risk management within the firm the so called Enterprise. risk management ERM Several definitions of this system have been found but all. agree about the fact that ERM is an integrated system of actions that companies take. to deal with risk It is generally put in practise within a framework like COSO s one. usually made by the phases of risk identification assessment and response followed. by monitoring activities Hedging and energy derivatives belong to the risk response. phase in the case a company decides to pursue the mitigation strategy A more. practical part of the chapter is devoted to concrete examples of how energy. companies apply ERM found in literature or taken from some energy companies. websites The usefulness of the given examples relies in the willingness of this thesis to. show the practical benefits of risk management practices for the energy companies. that are becoming important supports for strategic decisions as well. The ERM is not only made by organizational practices but it also needs to be. supported by quantitative tools to quantify and measure the risk Indeed the third. chapter provides an overview about the quantitative methodologies used with this. purpose VaR and similar measures are proposed as the main risk metrics to use in. tandem with energy derivatives because they also evaluate the risk involved in a. portfolio of derivatives Among all the techniques to compute VaR a particular. mention is for the Monte Carlo method because it seems to be the most suitable. technique to simulate the price fluctuations in a highly changing environment like the. energy one, In the fourth chapter the focus is on a specific tool of risk management which is that. of the energy derivatives An introduction of derivatives in general forecasts the. description of energy forwards futures swaps and options with some indications. about their evaluation and of the markets where transactions take place in Exchanges. or over the counter Then numerical techniques for the valuation of derivatives such. as Monte Carlo simulation and trinomial trees and numerical techniques to hedge the. exposure are described as well, Finally after a long work with the ambition of providing a complete descriptive.
overview about the central topic an applicative fifth and last chapter follows. Some applications of the practise of hedging against energy risk are proposed in order. to give the reader a concrete idea about the use of energy derivatives Simple. numerical examples for each commodity oil electricity and gas are given in order to. observe how the financial instruments studied in theory actually work and to capture. the gaps among commodities as well Moreover some concrete case studies coming. from geographically different markets or sectors directly or indirectly related to. commodities are mentioned This further step is done in order to have an evidence of. the benefits but also the pitfalls derived from the concrete application of these. instruments, The final part of the thesis includes some criticism that makes the core discussion of. the research to emerge If on the one hand energy derivatives are source of benefits. for energy companies because they allow to hedge against energy risk some cases. like the Enron one show that a misleading use of them may cause the opposite effect. Thereby the debate of the work as follows shows which are the conditions the. methodologies and the practises that may forecast a correct use of energy derivatives. so that they can produce the beneficial effects companies may take advantage from. Risk management, 1 1 A brief historical background. It is not an easy task to provide a unique definition of risk management In the financial. literature there is a plenty of definitions Crockford 1982. Furthermore the origins of this phenomena are not of the modern age even the. Egyptians cared about risk Froot Scharfstein and Stein 1994. Despite the interest that this argument may have had in ancient times the historical. step we are most interested in for the purpose of this thesis is the use of risk. management as a formal part of the decision making process within the companies. traceable to the late 1940s and early 1950s Dickinson 2001 Since then companies. demonstrated an increasing care about risk such that since the mid 1990 enterprise. risk management has emerged as a concept and as a management function within. corporations Dickinson 2001, The Enterprise risk management ERM that will be depth later on is the use from. the managers of methods and processes to manage various types of risks within the. organizations, The evolution of risk management led the multinationals to be the principal users of. risk management instruments Froot Scharfstein and Stein 1994. There are different methods they have historically used and they can choose to. manage the risk They can mitigate the risk through their investment decisions. through financing choices they can alternatively choose to buy insurances for specific. types of risks catastrophic events for instance finally they can transfer risk through. derivatives Damodaran 2007 These latest that will have a dedicated analysis are. the instruments I have decided to focus on as the tools of risk management with a. particular application to the companies operating in the energy sector. 1 2 Risk definition and measurement, Before dealing with the risk management process it is worthwhile to spend a word.
about what we mean for risk To exist risk must be characterized by two elements. uncertainty and impact on utility Holton 2004, In finance the risk may be considered as the probability of the potential loss. Two measures of the risk of a probability distribution are its variance and standard. deviation Berk DeMarzo 2011 We mean for variance the expected square. deviation from the mean while the standard deviation is the square root of the. Variance and Standard Deviation of the Return Distribution. When there is no risk the variance is zero, These are the most common measures of risk despite they do not distinguish. between downside and upside risk In fact as we will see in the further chapters risk. may be considered not only as a threat but also as an opportunity Damodaran 2007. Nevertheless they are not easy to interpret from the investors perspective more. interested to the probability of loss than to volatility. The VaR models are able to estimate the potential losses through the variance. covariance methodology Brown Reilly 2008, where R is the average return k is the confidence level we choose and is the. standard deviation, A big change in the risk consideration was introduced by Harry Markowitz who linked. the risk of a portfolio to the co movement with the individual assets in that portfolio. and found out a set of optimal portfolios at specific risk levels called efficient. frontier Damodaran 2007, Since Markowitz s theory what matters is not the volatilit.
an integrated risk management system within the enterprise In order to discuss the above mentioned topics and to answer to a research question requiring to illustrate the benefits of energy derivatives and risk management for the companies operating in the energy sector this thesis follows a logical process spread out five chapters

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