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2011/2012  KAN-OECON_OE34  Energy Markets, Real Options Investments, and Capital Structure

English Title
Energy Markets, Real Options Investments, and Capital Structure

Course Information

Language English
Point 7,5 ECTS (225 SAT)
Type Elective
Level Full Degree Master
Duration One Semester
Course Period Autumn
Time Table Please see course schedule at e-Campus
Max. participants 50
Study Board
Study Board for MSc in Advanced Economics and Finance
Course Coordinator
  • Kristian Miltersen - Department of Finance
Prof.: Kristian R. Miltersen - krm.fi@cbs.dk Secretary: Rikke Glahn - rg.eco@cbs.dk
Main Category of the Course
  • Finance

Taught under Open University-Taught under open university.
Last updated on 29 maj 2012
Learning Objectives
• Understand the concepts of irreversible investments as so-called real options
• Be able to evaluate and optimally decide on irreversible investment projects
• Understand commodity markets and the concept of convenience yields
• Understand derivatives markets of commodities and their relations to forward and future convenience yields
• Understand no-arbitrage bounds on prices of commodities due to cross product substitution
• Be able to model price processes of commodities incorporating the learning goals above based on continuous time stochastic processes
• Have a special focus on commodity markets related to energy products and to understand the special properties of energy markets including the electricity market
• Understand the firm’s capital structure and its influence on the firm’s optimal decisions to implement irreversible investments
• Understand how an industry’s competitive setting influence the firm’s optimal decisions to implement irreversible investments
Requires Derivatives and Risk Management and Corporate Finance from the MSc in Advanced Economics and Finance (cand.oecon.) program or similar curriculum.
Oral examination, 20 minutes
Oral exam:
Assessment Oral with Written Assignment
Marking Scale 7-step scale
Censorship External examiners
Exam Period Winter Term
Aids Open Book, Written and Electronic Aid is permitted
Duration 20 Minutes
Oral examination, 20 minutes, no preparation time, but prepared power point presentation is a part of the exam – see below. The examination has two parts:
Part 1 (10 minutes): Three weeks before the exam, the students are given 7-8 topics for which they have to prepare a 10 minute presentation. They should use power point slideshow (brought to the exam on a USB drive or the like), but they are not allowed to bring other notes or other exam aids for the exam. At the beginning of the examination, the student chooses one of the topics at random and immediately thereafter gives the presentation.
Part 2 (8-10 minutes): The student is asked questions in parts of the curriculum different from the part covered in part 1. The implementation exercises given during the semester are part of the curriculum and can be made a part of the examination.
Course Content

The course provides the students with a profound knowledge of key concepts, relations, and models in commodity markets in general and energy markets in particular. The first part of the class is devoted to real options analysis. The concepts learnt in Derivatives and Risk Management are translated into a powerful tool to analyze irreversible investments. Optimal investment timing as well as valuation of investment projects are analyzed. The second part of the class is devoted to understanding commodity markets and corresponding derivatives markets. We emphasize the concept of convenience yields and its relations to forwards and futures markets of commodities. The class focuses on energy markets in particular. Energy markets are challenging due to the number of cross product substitutions, the various competitive settings in the sector, the institutional details of the distribution channels of the different products, the different market structures, and the highly sophisticated derivatives markets. The last part of the course links the irreversible investment decisions (the real options theory) to the models of energy market, focusing in particular on how the optimal investment decisions is related to the competitive setting of the industry and the capital structure of the firms. We revisit classical theories of capital structure irrelevance (Modigliani and Miller) and debt overhang (Myers).

During the semester all students must hand in a written 3 pages paper covering a case analysis done in a two weeks period. The paper shall provide an executive summary of the contract, its pros and cons, and some key proposals for how to improve the contract. The case analysis and case presentation will take place in groups of no more than 4 students, but the written summaries are individual.

The course is a progression course building on the knowledge and learning goals from Corporate Finance and Derivatives and Risk Management from the MSc in Advanced Economics and Finance (cand.oecon.) program or similar curriculum from the other Master’s programs, e.g. the MSc in Applied Economics and Finance.

Teaching Methods
The format of the course is based on the following elements:
• Class lecture devoted to the fundamental theoretical issues
• Class exercises
• Two week case analysis

The curriculum will include parts of (but is not limited to):

Dixit and Pindyck (1994): Investments under Uncertainty, Princeton University Press

Dixit (1993): The Art of Smooth Pasting, Routledge.

Bendt, Bendt, and Koekebakker (2008): Stochastic Modeling of Electricity and Related Markets, World Scientific Publishing Company.

Journal articles and working papers.