In the three graphs below (labelled (b), (c) and (f) in Figure 1: Risk exposure by county), you can see three sets of weather-related risks to the United States caused by climate change. Historically, credit ratings agencies have not accounted for the physical risks of climate change. A whitepaper by Moodys from 2015 states:

Based on currently limited visibility into the nature, probability, and severity of the follow-on risks to a global warming trend (e.g. droughts, floods) combined with an extremely long projected time frame direct climate change hazards are not at present a material driver for ratings

Based on this information, and the knowledge we have developed in class on credit derivatives, answer the following questions:

1. How would the three types of risks differentially impact firms in the US?

2. How would these risks be priced in the CDS spreads associated with those firms?

3. How would this risk-pricing be affected if credit ratings agencies started to systematically consider the physical risks of climate change in their ratings?

4. Which of these risks are diversifiable? How would each risk affect the pricing of tranches in a CDO based on CDS contracts?

80 75 70 65 60 55 50 45 40 35 80 (b) Heat score 70 80 60 70 50 60 40 50 L 30 40 20 30 10 20 0 10 (f) Hurricane score 0 (c) Sealevel score Figure 1: Risk exposure by county 80 75 70 65 60 55 50 45 40 35 80 (b) Heat score 70 80 60 70 50 60 40 50 L 30 40 20 30 10 20 0 10 (f) Hurricane score 0 (c) Sealevel score Figure 1: Risk exposure by county