Financial Risk Management Flashcards
Interest rate goes up
Value of investment goes down
Diversifiable risk
Spread the risk
Market Risk
- Price Risk
Liquidity Risk
- Reducing private equity
Default Risk
Assess their risk of default
Ratios
Credit worthiness - Credit Risk Credit companies look at improve ratios to improve credit ratings
Derivative
A financial contract which derives its value from the performance of another asset or financial contract
DUNS
Diversifiable
Unsystematic
Nondiversifiable
Systematic
PUT option
sell a specific security at fixed conditions of price and time
Exchange Rate Risks
Exists because the relationship between domestic and foreign currencies may be subject to volatility
Exchange Rate Risks
Exists because the relationship between domestic and foreign currencies may be subject to volatility
Exchange Rate Factors
Trade and Financial
Trade Factor
Relative Inflation Rates
Purchasing Power
Relative income levels
Government Controls
Inflation up
Demand for currency goes down along with value
Inflation
Loss of purchasing power
Financial Factors
Pay high interest rates, demand and value goes up
US values goes down
FC goes up, alot of receivables in FC
PV goes up
US goods are cheap now thus exports
Exports are up because it’s now cheaper
US value goes up
FC goes down Domestic good more expensive thus exports
Translation Exposure
The more foreign subs, the greater the risk
Translation Exposure
The more foreign subs, the greater the risk
Selective Hedging
Forward, futures, options, swaps
FC goes up
Liabilities goes up, need to hedge
Identify the risk
AR>AP =
Net Asset/Net Export
AP>AR=
Net liability/ Import
Future Hedges
Smaller transaction
Standard amounts
Net liability
Imports are greater than exports = loss
Net liability
Imports are greater than exports = loss
AP Application
Buy call options
Buy futures contracts
If they dont hedge
Company incurs a foreign exchange loss
AR Application
Buy PUT options
Sell Future Contracts
Use profit to offset loss if FC goes down
Sell when you think it is going to go down, offset lower value of asset
Mitigrating Transaction Exposes (Option Hedges)
Buy call - cap on cost
But put - floor on rev
If foreign currency goes up
Buy call options on the foreign currency, use the profit to offset the higher accounts payable
