Basics In Corporate Risk Management 4 Flashcards
What is economic risk?
The possibility that something damaging could occur, resulting in loss or damage to assets, legal liability, or financial loss.
What is risk management?
The process of mitigating business risks or bringing them down to zero through appropriate steps.
List some steps involved in risk management.
- Implementation of corporate governance
- Risk identification and calculation of values at risk
- Agreement on favourable terms of payment
- Purchasing appropriate insurance policies.
What are the two main classifications of risk?
- Business risk
- Non-business risk
Define country risk.
The risk of a commercial transaction not being realized in a contractual way due to government or authority measures.
What are some underlying causes of country risks?
- Political instability
- Social and economic instability
- Government intervention, protectionism, and barriers to trade
- Bureaucracy, administrative delays, and corruption
- Lack of legal safeguards for intellectual property rights
- Conversion risk
- Transfer risk
- Payment prohibition and moratorium
What are some strategies to mitigate country risks?
- Investigation of macroeconomic data
- Analysis of country rating
- Export insurances offered by state- or private financial institutions.
What are product risks?
- Negligence concerning operating procedures
- Careless treatment
- Lack of current maintenance
- Damage due to climate or environmental reasons.
What are manufacturing risks?
- Tailor-made goods cannot be sold to others
- Insolvency of the buyer may provoke extra costs
- Down payments can lead to repayment risks.
What is purchaser risk?
The risk of the buyer’s incapability of fulfilling contractual obligations due to bankruptcy or insolvency.
What are some currency and financial risks?
- Currency exposure
- Asset valuation
- Foreign taxation
- Inflationary and transfer pricing.
List strategies to mitigate business risks.
- Use of appropriate terms of payment
- Application for bank guarantees
- Application for export- and/or credit insurances
- Use of cargo insurances
- Use of financial derivatives.
What are cross-cultural risks?
- Bribery
- Cultural differences
- Negotiation patterns
- Unusual payment settlements
- Unusual transfer instructions
- Complicated accounts structures.
What are financial derivatives?
Financial instruments linked to specific underlyings used to mitigate financial risks.
What is the difference between unconditioned and conditioned contracts in derivatives?
- Unconditioned contracts must be honored.
- Conditioned contracts depend on the decision of at least one party.
What are listed and non-listed derivatives?
- Listed derivatives are traded on exchanges.
- Non-listed derivatives (OTC) are not traded on exchanges.
What are the features of standardized contracts in derivatives?
- The underlying asset
- Contract size
- Strike price
- Maturity.
What is a forward contract?
An unconditional OTC contract tailored for two counterparties that cannot be easily transferred.
What is a futures contract?
A standardized derivative obligating parties to receive or deliver an underlying asset at a predetermined price.
What are the strategies available to a futures investor?
- Buy a futures contract (go long) to benefit from upward trends.
- Sell a futures contract (go short) to speculate on downturns.
What is an option in financial derivatives?
A contract that gives the holder the right but not the obligation to buy or sell an underlying asset at a specified price.
What scenarios can occur with a call option?
- Stock price < strike price: option not exercised, loss of premium.
- Stock price = strike price: no economic value, loss of premium.
- Stock price > strike price: option exercised, profit minus premium.
What is a swap contract?
A contract between two parties to exchange cash flows or other financial instruments.
What is the result when an investor exercises an option and the share price is exactly 103 USD?
The investor breaks even, realizing a gain of 3 USD that offsets the cost of the option.
What happens when the share price at the maturity date of the option is more than 103 USD?
The investor exercises the option, sells the shares immediately, and realizes a profit reduced by the cost of the option (USD 3).
Define a swap contract.
A swap is a contract between two parties agreeing to exchange cash flows on regular future dates, with the cash flows calculated on a different basis.
What type of agreement is a swap contract?
A bilateral unconditioned over-the-counter agreement directly negotiated between two parties, at least one of which is normally a bank or other financial institution.
True or False: Swaps are traditionally dealt with a central counterparty acting as guarantor.
False.
What is the risk involved in a swap contract?
Both sides have the risk that the other party might default on its obligations.
In an interest rate swap, how are cash flows typically structured?
One rate is fixed and the other is a floating rate linked to a key money market reference rate such as LIBOR or EURIBOR.
Fill in the blank: In a swap contract, XYZ Corp. pays a fixed interest rate of _______ p.a.
9.75%
Fill in the blank: The ABC-Bank pays a floating rate-based loan of _______ + 0.5%.
Euribor
What are the advantages of swap contracts? List at least three.
- Enables changes in the refinancing structure
- Hedging against currency and interest rate risks
- Micro- and Macro hedges are possible
- Individual contract design
What are the disadvantages of swap contracts? List at least two.
- Counterparty risk
- Unconditioned contracts
Criticism on derivatives: Are derivatives a source of losses?
Yes, when they are truly complex and created for speculative reasons only.
Criticism on derivatives: Are derivatives speculative?
Yes, because they contain a high degree of embedded leverage.
Criticism on derivatives: Do derivatives spread risk in the financial system in a controlled way?
No, they spread risk in an uncontrolled way.
