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CTP 6th Edition > CH17-Financial Risk Management > Flashcards

CH17-Financial Risk Management Flashcards

1
Q

define Implicit Risk

A

type of Transaction Risk - Cash flow exposure

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2
Q

define Explicit Risk

A

type of Transaction Risk - Balance sheet exposure

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3
Q

define Translation Risk

A

AKA Accounting Exposure.
When a company holds assets or liabilities in a currency other than its functional currency. Must be converted (translated) into Reporting currency. Exchange rate.

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4
Q

Natural hedging

pg541

A

used to address FX risk.
Company holds assets and liabilities in same currency; they offset each other when market fluctuates: borrow/invest, fixed/floating, balance sheet matching, fixed-price supply

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5
Q

Active hedging

pg542

A

Similar to buying insurance to insure asset’s value (or liability’s risk) when market fluctuates

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6
Q

Arbitrage

pg542

A

no-risk attempt to profit from market inefficiencies: buy asset in one market and simultaneously sell in another

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7
Q

Speculation

pg542

A

Betting on market direction to profit: not a normal treasury objective unless part of strategy

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8
Q

Forwards Contracts

A

agreement between two parties to buy or sell a fixed amount of an asset at a future date at an agreed upon price today

  • underlying asset
  • Future date (maturity of contract)
  • price is delivery price of contact
  • Buying party is LONG on a forward contract
  • Selling party (counter party) (bank/FX dealer) is SHORT on a forward contract
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9
Q

Forwards Contract - who is long / short

A

Fwd Contract
LONG=Buyer
SHORT=Seller/Bank/FX Dealer

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10
Q

Futures Contracts

A

standardized contract traded on an organized exchange, which serves as the counterparty to all trades

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11
Q

Attributes of a Futures Contract

A
  • Organized on an Exchange
  • virtually eliminates counterparty risk
  • LONG=Buyer
  • SHORT=Seller
  • Size and maturity date set by Exchange (standardized)
  • Requires Margin Account which is covered at EOD
  • Marked to market
  • Rarely settled; closed out prior to maturity
  • Government regulated (CFTC / FCA)
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12
Q

Attributes of a Forwards Contract

A

-customized contract between two parties (not on an exchange)

  • underlying asset
  • Negotiable expiration date=Future date (maturity of contract)
  • price is delivery price of contact
  • LONG=Buyer
  • SHORT=Seller
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13
Q

Options

A

contract giving buyer right (not obligation) to buy or sell fixed amount of underlying asset at a fixed price on or before specified date

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14
Q

Call Option

A

Right to Buy an asset

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15
Q

Put Option

A

Right to Sell an asset

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16
Q

Strike/Exercise Price

A

Fixed price of underlying asset on an Option

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17
Q

3 Styles of Options, ranked by Size of Premium

A

Highest premium: American Option
Middle premium: Bermudan Option
Lowest premium: European Option

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18
Q

When is American Option date of exercise?

A

Any time on or before delivery date. Most likely to be exercised.

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19
Q

When is Bermudan Option date of exercise?

A

At specified dates over the option’s life

20
Q

When is European Option date of exercise?

A

On delivery date ONLY. Least likely to be exercised.

21
Q

When an option is In The Money, is it profitable?

A

Not necessarily. Must consider Premium

22
Q

What general approach do “IAS 21: The Effects of Changes in Foreign Exchange Rates” and “ASC Topic 830: Foreign Currency Matters” both follow regarding translation risk?

A

Helps firms to assess the specific impact that changing FX rates have when translating financial statements

23
Q

define Interest Rate Collar

A

CAP + FLOOR = COLLAR

an interest rate CAP + an interest rate FLOOR = interest rate COLLAR.

Cap = maximum borrowing rate, thereby protecting the company against higher interest rates

Floor = minimum borrowing rate.

24
Q

An investor who wants to hedge the possibility of a fall in the price of an asset could perform which of the following actions?

A

Buy a put option

A put option gives the contract owner the right, but not the obligation, to sell (put) the underlying asset to the contract writer at a fixed price through the delivery date.

25
Q

Four basic types of derivative securities

A

forwards, futures, swaps and options.

26
Q

Define Window Forward

A

variation of a standard forward contract.

allows settlement during a given “window” period

27
Q

Economic Risk

A

AKA Operating Risk: LT effect of changes in exchange rates on the PV of future CFs

28
Q

Transaction Risk

A

a company creates receivables, payables denominated in a currency other than its functional currency. Ultimate value of collected AR / paid AP is a different value than when created

29
Q

2 parts of Transaction Risk

A
  1. CF exposure (implicit risk) - time between when sale is made and price is set vs cash collected
  2. BS exposure (explicit risk) - time between when transaction occurs vs finally settled
30
Q

Translation Risk (accounting exposure) guidance

A

In the US: ASC 830 - Foreign Currency Matters

Global: IAS 21 - The Effects of Changes in Foreign Exhange Rates

Both helps firms assess the specific impact that changing FX rates have when translating financial statements

31
Q

Less variability in expected future cash flows increases a firm’s value in 4 ways:

A
  1. greater predictability of CFs
  2. lenders view the company as less risky, which enhances borrowing advantage in credit markets
  3. company can assess costs and revenues more accurately, which decreases financial distress
  4. can prepare more accurate budgets b/c doesn’t need to make allowances for price volatility, which sets more competitive pricing
32
Q

T/F: Using hedging to reduce the variability in expected future cash flows creates an advantage in the credit markets

A

True

33
Q

__________ is the most common method companies use to lower the volatility of future cash flows and consequently lower their perceived investment risk

A

Hedging

34
Q

On a Forwards Contract, the LONG makes money when…

A

Long=Buyer

Long makes money when ASSET PRICE RISES

35
Q

On a Forward Contract, the SHORT makes money when…

A

Short=Seller = make money when asset SINKS

Short makes money when ASSET PRICE SINKS (falls)

36
Q

Call Option = Buy

A

make money when asset price rises

37
Q

Put Option = Sell

A

make money when asset price Sinks

38
Q

What does it mean when an option is At-The-Money

A

Asset price = Strike price

39
Q

formula to calc profit/(loss) on an option contract

A

(Current Asset Price - Strike Price - Premium) = P/L

40
Q

formula to calc break even or profit/(loss) on a Put option contract

A

(Strike - Premium) = Put Option B/Even

(Strike - Premium -1) = Put Option become Profitable

41
Q

Which ASC topic helps determine the real market price of an asset?

A

ASC 820-10: Fair Value Measurement-Overall

42
Q

3 greater challenges in global treasury over domestic

A

Increased risk of:
FX risk,
Cash Flow Complexity,
Tax issues

43
Q

Which currency can be managed using mainstream risk management instruments and techniques?

A

Euro = A currency that has externally controlled monetary policy and single-currency, cross-border pooling

44
Q

A currency that has externally controlled monetary policy and single-currency, cross-border pooling =

A

Euro

45
Q

T/F: When an advantage to investing in another country’s money market exists, it will be eliminated quickly because exchange rates adjust to the cross-border money flows created by investors as they attempt to capture the advantage

A

True

46
Q

What was a downside of the mark-to-market valuation approach for derivatives that required updated guidance within ASC Topics 815 and 820 and similar updates to IFRS guidelines?

A

If one asset class rapidly deteriorates in value it can cause illiquidity in other markets

47
Q

2 Primary issues addressed by FASB and IASB regarding derivatives

A

Valuation and Disclosure

CTP 6th Edition (64 decks)

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