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Weather Derivative

Definition of Weather Derivative

A weather derivative is a futures contract ÔÇö or options on that futures contract ÔÇö where the underlying commodity is a weather index. These derivatives work much the same way that interest-rate or stock index futures and options do, by creating a tradable commodity out of something that is relatively intangible. Analysts look at historical weather patterns ÔÇö temperature, rainfall and other things ÔÇö develop averages, and quantify the risk that weather will deviate from the average. Corporations use weather derivatives to hedge their risk that bad weather will cause a financial loss. For a cereal company, bad weather might be a drought, which would cause wheat prices to go up. For a home heating company, it could be warm days in November, which could lower demand for home heating oil. And for an amusement park it could be rain. The cereal company and the amusement park might buy futures contracts with an underlying weather index based on rainfall. The home heating company might want contracts based on a temperature index. Weather derivatives are different from insurance, because theyÔÇÖre linked to common weather events, like dry seasons, or a warm autumn, that affect particular businesses. Insurance is still required to protect against major weather events, like tornadoes, hurricanes, and floods. You can buy weather derivatives as an individual, but youÔÇÖll want to consider the trading costs carefully to ensure that your risk of loss is worth the expense.

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Financial Dictionary

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Financial Dictionary is a dictionary or database that contains the meaning of all financial terms. Financial Dictionary has been created to help anyone, interested in understanding financial terms. It is extremely important to know what the financial terms mean when signing on terms and conditions. When availing financial products, you can be easily cheated if you don’t know what you have signed up for. To avoid this, you must be aware on what the terms really mean.

 

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We have developed this Financial Dictionary that could be used by anyone for free on our website. We have provided the meanings of almost all the financial terms along with the context in which they can be used. If you have lingering doubts on any financial term, then all you must do is log on to our website and check out the Financial Dictionary.

 

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