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Related Flashcards
Cards In This Set
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What is Risk?
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- “A possible future event which if it occurs will lead to an undesirable outcome.” - “Risk is the possibility of suffering loss.”
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What is Risk Management?
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“Risk Management can be roughly defined as any set of actions taken by individuals or corporations in an effort to alter the risk arising from their primary line(s) of business.”
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What is a hedge?
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“A hedge is a financial position – often a derivative - put on to reduce the impact of a risk one is exposed to…”
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Risk management process?
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1. Identify relevant risk factors.2. Understand the distribution of those risk factors3. Estimate the impact of adverse movements in those risk factors on the strategic plan.4. Decide whether to hedge or not.5. Choose the appropriate financial instrument.6. Determine how much to hedge.
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Potential risk factors?
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Exchange Rate RiskInterest Rate RiskCommodity Price RiskCredit Risk Equity Price RiskOperational RiskPolitical risk
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Tactical Risk Management
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Involves the hedging of contracts or other explicit future commitments of the firm such as exchange rate risk. The treasurer of the firm typically executes such tactical currency hedging without consideration of other hedging or insurance activities carried out in the firm, even when the risks across units are significantly correlated.
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‘Strategic’ Risk Management (also called ‘Integrated Risk Management’)
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Involves the identification and assessment of the collective risks that affect firm value and the implementation of a firm-wide strategy to manage those risks.
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How to reduce risk exposure?
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1. Diversify product line 2. Manage Expenditure 3. Reduce Leverage4. Use Derivatives
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What is a derivative?
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“A derivative is a financial instrument with promised payoffs derived from the value of one or several contractually specific underlyings.”
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What are the two flavours of a derivative?
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Plain Vanilla & Exotic
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Plain Vanilla derivatives?
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Plain Vanilla- Forward Contracts- Futures Contracts- Options Contracts
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Exotic derivatives?
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Exotic= Derivative whose payoff cannot be replicated by a combination of options and futures.- exotic swap- binary option
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Derivative trading happens on...
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Derivatives are traded:(a) on an exchange(b) over-the-counter (OTC)
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Main types of derivatives
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1. Options2. Forward contract3. Futures contract4. Swaps
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Call option?
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A call option is a security which conveys the right to buy a specified quantity of an underlying asset at a contractually agreed price at or before a fixed date.
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