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How Financial Engineering Can Advance Corporate Strategy

In: Business and Management

Submitted By shabbir9
Words 1211
Pages 5
Question 1 – Enron Case:

A. Fixed volume at fixed price. – Production companies who use the natural gas as a material in producing their final product. By fixing the price, they insure themselves from increasing prices and can forecast and meet their budgeted costs as well as budgeted profit margins. B. Fixed volume at price tied to a natural gas index. – Speculators who will engage in risky financial transactions in an attempt to profit from fluctuations in the market value of a tradable good. They focus purely on price movements.

C. Fixed volume at price tied to a natural gas index and capped at a determined level - Utility companies, who know the required volume and will prefer to purchase contract where prices are tied to a natural gas index, if the prices go down they will not lose money however, at the same time by capping at a determined level they are insuring themselves from increasing prices.

Question 2 - Tennessee Valley Authority Case:

A. Tennessee Valley Authority (TVA) could add capacity to provide power to its customers without actually building physical plants by purchasing call options. These options would allow TVA the right to exercise the option in order to meet demand. Should there be no demand at that particular time TVA simply would not execute their call options. Main Constraint –since TVA is purchasing physical settlement, the credit rating of suppliers is very important, which means TVA can have option purchase agreements (OPAs) only with suppliers with a AAA rating, which limit the number of suppliers. The other constrain is regarding how the actual product will be delivered. Considering the fact that it is hard to store electricity and deliver. TVA can have OPAs only with companies who can actually deliver the product.

B. Physical settlement derivatives would be required to execute...

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