Beruflich Dokumente
Kultur Dokumente
23.1
Key Concepts and Skills Understand the types of volatility that companies can manage Understand how to develop risk profiles Understand the difference between forward contracts and futures contracts and how they are used for hedging Understand how swaps can be used for hedging Understand how options can be used for hedging
McGraw-Hill/Irwin
23.2
Chapter Outline Hedging and Price Volatility Managing Financial Risk Hedging with Forward Contracts Hedging with Futures Contracts Hedging with Swap Contracts Hedging with Option Contracts
McGraw-Hill/Irwin
23.3
Example: Disneys Risk Management Policy Disney provides stated policies and procedures concerning risk management strategies in its annual report
The company tries to manage exposure to interest rates, foreign currency, and the fair market value of certain investments Interest rate swaps are used to manage interest rate exposure Options and forwards are used to manage foreign exchange risk in both assets and anticipated revenues Derivative securities are used only for hedging, not speculation
McGraw-Hill/Irwin
23.4
Hedging Volatility Recall that volatility in returns is a classic measure of risk Volatility in day-to-day business factors often leads to volatility in cash flows and returns If a firm can reduce that volatility, it can reduce its business risk Instruments have been developed to hedge the following types of volatility
Interest Rate Exchange Rate Commodity Price
McGraw-Hill/Irwin
23.5
Interest Rate Volatility Debt is a key component of a firms capital structure Interest rates can fluctuate dramatically in short periods of time Companies that hedge against changes in interest rates can stabilize borrowing costs This can reduce the overall risk of the firm Available tools: forwards, futures, swaps, futures options and options
McGraw-Hill/Irwin
23.6
Exchange Rate Volatility Companies that do business internationally are exposed to exchange rate risk The more volatile the exchange rates, the more difficult it is to predict the firms cash flows in its domestic currency If a firm can manage its exchange rate risk, it can reduce the volatility of its foreign earnings and do a better analysis of future projects Available tools: forwards, futures, swaps, futures options
McGraw-Hill/Irwin
23.7
McGraw-Hill/Irwin
23.8
The Risk Management Process Identify the types of price fluctuations that will impact the firm Some risks are obvious, others are not Some risks may offset each other, so it is important to look at the firm as a portfolio of risks and not just look at each risk separately You must also look at the cost of managing the risk relative to the benefit derived Risk profiles are a useful tool for determining the relative impact of different types of risk
McGraw-Hill/Irwin
23.9
Risk Profiles Basic tool for identifying and measuring exposure to risk Graph showing the relationship between changes in price versus changes in firm value Similar to graphing the results from a sensitivity analysis The steeper the slope of the risk profile, the greater the exposure and the more a firm needs to manage that risk
McGraw-Hill/Irwin
23.10
Timing
Short-run exposure (transactions exposure) can be managed in a variety of ways Long-run exposure (economic exposure) almost impossible to hedge, requires the firm to be flexible and adapt to permanent changes in the business climate
McGraw-Hill/Irwin
2003 The McGraw-Hill Companies, Inc. All rights reserved.
23.11
Forward Contracts
A contract where two parties agree on the price of an asset today to be delivered and paid for at some future date Forward contracts are legally binding on both parties They can be tailored to meet the needs of both parties and can be quite large in size Positions
Long agrees to buy the asset at the future date Short agrees to sell the asset at the future date
Because they are negotiated contracts and there is no exchange of cash initially, they are usually limited to large, creditworthy corporations
McGraw-Hill/Irwin
23.12
Figure 23.7
McGraw-Hill/Irwin
23.13
Because it eliminates the price risk, it prevents the firm from benefiting if prices move in the companys favor The firm also has to spend some time and/or money evaluating the credit risk of the counterparty Forward contracts are primarily used to hedge exchange rate risk
McGraw-Hill/Irwin
2003 The McGraw-Hill Companies, Inc. All rights reserved.
23.14
Futures Contracts Forward contracts traded on an organized securities exchange Require an upfront cash payment called margin
Small relative to the value of the contract Marked-to-market on a daily basis
Clearinghouse guarantees performance on all contracts The clearinghouse and margin requirements virtually eliminate credit risk
McGraw-Hill/Irwin
2003 The McGraw-Hill Companies, Inc. All rights reserved.
23.15
Futures Quotes
See Table 23.1 Commodity, exchange, size, quote units
The contract size is important when determining the daily gains and losses for marking-to-market
Delivery month
Open price, daily high, daily low, settlement price, change from previous settlement price, contract lifetime high and low prices, open interest The change in settlement price times the contract size determines the gain or loss for the day
Long an increase in the settlement price leads to a gain Short an increase in the settlement price leads to a loss
23.16
McGraw-Hill/Irwin
23.17
Swaps A long-term agreement between two parties to exchange cash flows based on specified relationships Can be viewed as a series of forward contracts Generally limited to large creditworthy institutions or companies Interest rate swaps the net cash flow is exchanged based on interest rates Currency swaps two currencies are swapped based on specified exchange rates or foreign vs. domestic interest rates
McGraw-Hill/Irwin
23.18
Pay Company A Swap Dealer w/A Company B Swap Dealer w/B Swap Dealer Net
McGraw-Hill/Irwin
23.19
Figure 23.10
McGraw-Hill/Irwin
23.20
Option Contracts
The right, but not the obligation, to buy (sell) an asset for a set price on or before a specified date
Call right to buy the asset Put right to sell the asset Exercise or strike price specified price Expiration date specified date
Buyer has the right to exercise the option, the seller is obligated
Call option writer is obligated to sell the asset if the option is exercised Put option writer is obligated to buy the asset if the option is exercised
Unlike forwards and futures, options allow a firm to hedge downside risk, but still participate in upside potential Pay a premium for this benefit
McGraw-Hill/Irwin
2003 The McGraw-Hill Companies, Inc. All rights reserved.
23.21
0 -10 0 -20 Payoff -30 -40 -50 -60 -70 Stock Price
2003 The McGraw-Hill Companies, Inc. All rights reserved.
20
40
60
80 100
McGraw-Hill/Irwin
23.22
20
40
60
80 100
Payoff
Payoff
Stock Price
2003 The McGraw-Hill Companies, Inc. All rights reserved.
McGraw-Hill/Irwin
23.23
Exercising a put
Owner of put receives a short position in the futures contract plus cash equal to the difference between the futures price and the exercise price Seller of put receives a long position in the futures contract and pays cash equal to the difference between the futures price and the exercise price
McGraw-Hill/Irwin
23.24
Hedging Exchange Rate Risk with Options May use either futures options on currency or straight currency options Used primarily by corporations that do business overseas US companies want to hedge against a strengthening dollar (receive fewer dollars when you convert foreign currency back to dollars) Buy puts (sell calls) on foreign currency
Protected if the value of the foreign currency falls relative to the dollar Still benefit if the value of the foreign currency increases relative to the dollar Buying puts is less risky
McGraw-Hill/Irwin
23.25
McGraw-Hill/Irwin
23.26
Quick Quiz What are the four major types of derivatives discussed in the chapter? How do forwards and futures differ? How are they similar? How do swaps and forwards differ? How are they similar? How do options and forwards differ? How are they similar?
McGraw-Hill/Irwin