Price risk management in the copper market using commodity derivatives and options strategies

Metals price risk management is a key issue related to financial risk in metal markets because of uncertainty of commodity price fluctuation, exchange rate, interest rate changes and huge price risk either to metals’ producers or consumers. Thus, it has been taken into account by all participants in metal markets including metals’ producers, consumers, merchants, banks, investment funds, speculators, traders and so on. Managing price risk provides stable income for both metals’ producers and consumers, so it increases the chance that a firm will invest in attractive projects. The purpose of this research is to evaluate risk management strategies in the copper market. The main tools and strategies of price risk management are hedging and other derivatives such as futures contracts, swaps and options contracts. Hedging is a transaction designed to reduce or eliminate price risk. Derivatives are financial instruments, whose returns are derived from other financial instruments and they are commonly used for managing financial risks. Although derivatives have been around in some form for centuries, their growth has accelerated rapidly during the last 20 years. Nowadays, they are widely used by financial institutions, corporations, professional investors, and individuals. This project is focused on the over-the-counter (OTC) market and its products such as exotic options, particularly Asian options. The first part of the project is a description of basic derivatives and risk management strategies. In addition, this part discusses basic concepts of spot and futures (forward) markets, benefits and costs of risk management and risks and rewards of positions in the derivative markets. The second part considers valuations of commodity derivatives. In this part, the options pricing model DerivaGem is applied to Asian call and put options on London Metal Exchange (LME) copper because it is important to understand how Asian options are valued and to compare theoretical values of the options with their market observed values. Predicting future trends of copper prices is important and would be essential to manage market price risk successfully. Therefore, the third part is a discussion about econometric commodity models. Based on this literature review, the fourth part of the project reports the construction and testing of an econometric model designed to forecast the monthly average price of copper on the LME. More specifically, this part aims at showing how LME copper prices can be explained by means of a simultaneous equation structural model (two-stage least squares regression) connecting supply and demand variables. A simultaneous econometric model for the copper industry is built: {█(Q_t^D=e^((-5.0485))∙P_((t-1))^((-0.1868) )∙〖GDP〗_t^((1.7151) )∙e^((0.0158)∙〖IP〗_t ) @Q_t^S=e^((-3.0785))∙P_((t-1))^((0.5960))∙T_t^((0.1408))∙P_(OIL(t))^((-0.1559))∙〖USDI〗_t^((1.2432))∙〖LIBOR〗_((t-6))^((-0.0561))@Q_t^D=Q_t^S )┤ P_((t-1))^CU=e^((-2.5165))∙〖GDP〗_t^((2.1910))∙e^((0.0202)∙〖IP〗_t )∙T_t^((-0.1799))∙P_(OIL(t))^((0.1991))∙〖USDI〗_t^((-1.5881))∙〖LIBOR〗_((t-6))^((0.0717) Where, Q_t^D and Q_t^Sare world demand for and supply of copper at time t respectively. P(t-1) is the lagged price of copper, which is the focus of the analysis in this part. GDPt is world gross domestic product at time t, which represents aggregate economic activity. In addition, industrial production should be considered here, so the global industrial production growth that is noted as IPt is included in the model. Tt is the time variable, which is a useful proxy for technological change. A proxy variable for the cost of energy in producing copper is the price of oil at time t, which is noted as POIL(t ) . USDIt is the U.S. dollar index variable at time t, which is an important variable for explaining the copper supply and copper prices. At last, LIBOR(t-6) is the 6-month lagged 1-year London Inter bank offering rate of interest. Although, the model can be applicable for different base metals' industries, the omitted exogenous variables such as the price of substitute or a combined variable related to the price of substitutes have not been considered in this study. Based on this econometric model and using a Monte-Carlo simulation analysis, the probabilities that the monthly average copper prices in 2006 and 2007 will be greater than specific strike price of an option are defined. The final part evaluates risk management strategies including options strategies, metal swaps and simple options in relation to the simulation results. The basic options strategies such as bull spreads, bear spreads and butterfly spreads, which are created by using both call and put options in 2006 and 2007 are evaluated. Consequently, each risk management strategy in 2006 and 2007 is analyzed based on the day of data and the price prediction model. As a result, applications stemming from this project include valuing Asian options, developing a copper price prediction model, forecasting and planning, and decision making for price risk management in the copper market.

Free Troposphere Ozone and Carbon Monoxide over the North Atlantic for 2001-2011

Carbon Monoxide (CO) and Ozone (O3) are considered to be one of the most important atmospheric pollutants in the troposphere with both having significant effects on human health. Both are included in the U.S. E.P.A list of criteria pollutants. CO is primarily emitted in the source region whereas O3 can be formed near the source, during transport of the pollution plumes containing O3 precursors or in a receptor region as the plumes subside. The long chemical lifetimes of both CO and O3 enable them to be transported over long distances. This transport is important on continental scales as well, commonly referred to as inter-continental transport and affects the concentrations of both CO and O3 in downwind receptor regions, thereby having significant implications for their air quality standards. Over the period 2001-2011, there have been decreases in the anthropogenic emissions of CO and NOx in North America and Europe whereas the emissions over Asia have increased. How these emission trends have affected concentrations at remote sites located downwind of these continents is an important question. The PICO-NARE observatory located on the Pico Mountain in Azores, Portugal is frequently impacted by North American pollution outflow (both anthropogenic and biomass burning) and is a unique site to investigate long range transport from North America. This study uses in-situ observations of CO and O3 for the period 2001-2011 at PICO-NARE coupled with output from the full chemistry (with normal and fixed anthropogenic emissions) and tagged CO simulations in GEOS-Chem, a global 3-D chemical transport model of atmospheric composition driven by meteorological input from the Goddard Earth Observing System (GEOS) of the NASA Global Modeling and Assimilation Office, to determine and interpret the trends in CO and O3 concentrations over the past decade. These trends would be useful in ascertaining the impacts emission reductions in the United States have had over Pico and in general over the North Atlantic. A regression model with sinusoidal functions and a linear trend term was fit to the in-situ observations and the GEOS-Chem output for CO and O3 at Pico respectively. The regression model yielded decreasing trends for CO and O3 with the observations (-0.314 ppbv/year & -0.208 ppbv/year respectively) and the full chemistry simulation with normal emissions (-0.343 ppbv/year & -0.526 ppbv/year respectively). Based on analysis of the results from the full chemistry simulation with fixed anthropogenic emissions and the tagged CO simulation it was concluded that the decreasing trends in CO were a consequence of the anthropogenic emission changes in regions such as USA and Asia. The emission reductions in USA are countered by Asian increases but the former have a greater impact resulting in decreasing trends for CO at PICO-NARE. For O3 however, it is the increase in water vapor content (which increases O3 destruction) along the pathways of transport from North America to PICO-NARE as well as around the site that has resulted in decreasing trends over this period. This decrease is offset by increase in O3 concentrations due to anthropogenic influence which could be due to increasing Asian emissions of O3 precursors as these emissions have decreased over the US. However, the anthropogenic influence does not change the final direction of the trend. It can thus be concluded that CO and O3 concentrations at PICO-NARE have decreased over 2001-2011.