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.

Evaluating the usefulness of soil moisture (forecasts) in streamflow prediction for central Texas

The past decade has brought significant advancements in seasonal climate forecasting. However, water resources decision support and management continues to be based almost entirely on historical observations and does not take advantage of climate forecasts. This study builds on previous work that conditioned streamflow ensemble forecasts on observable climate indicators, such as the El Niño-Southern Oscillation (ENSO) and the Pacific Decadal Oscillation (PDO) for use in a decision support model for the Highland Lakes multi-reservoir system in central Texas operated by the Lower Colorado River Authority (LCRA). In the current study, seasonal soil moisture is explored as a climate indicator and predictor of annual streamflow for the LCRA region. The main purpose of this study is to evaluate the correlation of fractional soil moisture with streamflow using the 1950-2000 Variable Infiltration Capacity (VIC) Retrospective Land Surface Data Set over the LCRA region. Correlations were determined by examining different annual and seasonal combinations of VIC modeled fractional soil moisture and observed streamflow. The applicability of the VIC Retrospective Land Surface Data Set as a data source for this study is tested along with establishing and analyzing patterns of climatology for the watershed study area using the selected data source (VIC model) and historical data. Correlation results showed potential for the use of soil moisture as a predictor of streamflow over the LCRA region. This was evident by the good correlations found between seasonal soil moisture and seasonal streamflow during coincident seasons as well as between seasonal and annual soil moisture with annual streamflow during coincident years. With the findings of good correlation between seasonal soil moisture from the VIC Retrospective Land Surface Data Set with observed annual streamflow presented in this study, future research would evaluate the application of NOAA Climate Prediction Center (CPC) forecasts of soil moisture in predicting annual streamflow for use in the decision support model for the LCRA.

Development of a continuum mechanics model of passive skeletal muscle

Skeletal muscle force evaluation is difficult to implement in a clinical setting. Muscle force is typically assessed through either manual muscle testing, isokinetic/isometric dynamometry, or electromyography (EMG). Manual muscle testing is a subjective evaluation of a patient’s ability to move voluntarily against gravity and to resist force applied by an examiner. Muscle testing using dynamometers adds accuracy by quantifying functional mechanical output of a limb. However, like manual muscle testing, dynamometry only provides estimates of the joint moment. EMG quantifies neuromuscular activation signals of individual muscles, and is used to infer muscle function. Despite the abundance of work performed to determine the degree to which EMG signals and muscle forces are related, the basic problem remains that EMG cannot provide a quantitative measurement of muscle force. Intramuscular pressure (IMP), the pressure applied by muscle fibers on interstitial fluid, has been considered as a correlate for muscle force. Numerous studies have shown that an approximately linear relationship exists between IMP and muscle force. A microsensor has recently been developed that is accurate, biocompatible, and appropriately sized for clinical use. While muscle force and pressure have been shown to be correlates, IMP has been shown to be non-uniform within the muscle. As it would not be practicable to experimentally evaluate how IMP is distributed, computational modeling may provide the means to fully evaluate IMP generation in muscles of various shapes and operating conditions. The work presented in this dissertation focuses on the development and validation of computational models of passive skeletal muscle and the evaluation of their performance for prediction of IMP. A transversly isotropic, hyperelastic, and nearly incompressible model will be evaluated along with a poroelastic model.

Using a Prediction and Option Generation Paradigm to Understand Decision Making

In many complex and dynamic domains, the ability to generate and then select the appropriate course of action is based on the decision maker's "reading" of the situation--in other words, their ability to assess the situation and predict how it will evolve over the next few seconds. Current theories regarding option generation during the situation assessment and response phases of decision making offer contrasting views on the cognitive mechanisms that support superior performance. The Recognition-Primed Decision-making model (RPD; Klein, 1989) and Take-The-First heuristic (TTF; Johnson & Raab, 2003) suggest that superior decisions are made by generating few options, and then selecting the first option as the final one. Long-Term Working Memory theory (LTWM; Ericsson & Kintsch, 1995), on the other hand, posits that skilled decision makers construct rich, detailed situation models, and that as a result, skilled performers should have the ability to generate more of the available task-relevant options. The main goal of this dissertation was to use these theories about option generation as a way to further the understanding of how police officers anticipate a perpetrator's actions, and make decisions about how to respond, during dynamic law enforcement situations. An additional goal was to gather information that can be used, in the future, to design training based on the anticipation skills, decision strategies, and processes of experienced officers. Two studies were conducted to achieve these goals. Study 1 identified video-based law enforcement scenarios that could be used to discriminate between experienced and less-experienced police officers, in terms of their ability to anticipate the outcome. The discriminating scenarios were used as the stimuli in Study 2; 23 experienced and 26 less-experienced police officers observed temporally-occluded versions of the scenarios, and then completed assessment and response option-generation tasks. The results provided mixed support for the nature of option generation in these situations. Consistent with RPD and TTF, participants typically selected the first-generated option as their final one, and did so during both the assessment and response phases of decision making. Consistent with LTWM theory, participants--regardless of experience level--generated more task-relevant assessment options than task-irrelevant options. However, an expected interaction between experience level and option-relevance was not observed. Collectively, the two studies provide a deeper understanding of how police officers make decisions in dynamic situations. The methods developed and employed in the studies can be used to investigate anticipation and decision making in other critical domains (e.g., nursing, military). The results are discussed in relation to how they can inform future studies of option-generation performance, and how they could be applied to develop training for law enforcement officers.