Lecture 8

Question 1

What is risk management for organisations?

Answer 1

Essential for long term survival - many businesses have failed because there wasn’t adequate policies
Business must identify, measure and manage risk
some risk is common and some is business specific

Question 2

What are some internal risk management strategies?

Answer 2

Natural hedges:
Borrowing money in the currency your revenue is in: If currency strengthens then win on revenue but loses on loan repayments
If currency weakens then loses on revenue but wins on repayments

Question 3

What are some external risk management strategies?

Answer 3

Use derivative products

Question 4

What is the effective risk management acronym?

Answer 4

Identifying exposures

Quantifying the exposure

Evaluating the exposures

Managing the exposures

Question 5

What is some background on derivatives?

Answer 5

Designed to manage risk. Value is derived from the value of an underlying commodity or instrument.
Basic function is to lock in a price today that will apply at a specified future date.

Question 6

What has changed in derivative markets over the last 30 years?

Answer 6

Substantially grown in size and variety because of deregulation, advances in tech and volatility in some markets.

Question 7

Who are the users of derivative markets?

Answer 7

1. Hedgers:-
   
   • use the market to lock in a future price and hence
     make their future cash flows more certain.
   • have an underlying position in the asset.
2. Speculators
   
   • using the market to bet on a price change.
   • have no underlying position in the asset.
3. Arbitrageurs
   
   • trade on mispricing between the derivatives
     and spot markets or between different
     derivative contracts to make a riskless profit.

Question 8

What are some common risks to hedge in derivative markets?

Answer 8

1. Commodity price risk
2. Interest rate risk
3. Currency risk
4. Share market risk

Question 9

Difference between forward and futures contract?

Answer 9

Futures vs Forward vs Spot

Spot:- 		Price Today, Delivery Today.

Forward:-		Price Today, Delivery at a
				Future Date.

Futures:-		Price Today, Delivery at a
				Future Date, BUT have 
				a secondary market.

Question 10

What’s one important and two confusing aspects of futures?

Answer 10

It’s a zero sum game.

1. you can sell first and buy later
2. with cash settlement the asset is never exchanged

Question 11

What are 3 types of financial futures?

Answer 11

Bank Bills
Commonwealth Bond Futures
Share Price Index futures

Question 12

Who are the uses of futures markets?

Answer 12

Hedgers - worried about fall - sell

• worried about rise - buy
  2. speculators
  3. arbitrageurs

Question 13

What is some background on options?

Answer 13

Gives buyer right but not obligation to buy/sell at specified price
Call Options are right to buy
Put Options are right to sell
Buyer pays premium to seller because losses are limited but there is potential for profit
They give greater flexibility than futures but come at a premium

Question 14

Who are the users of options markets?

Answer 14

1. Hedgers
worried about fall - buy put options
worried about rise - buy call options
2. speculators
3. arbitrageurs

Question 15

What are 6 variables relevant to options share price?

Answer 15

Share Price (S)

Exercise Price (X)

Standard Deviation of Return of Share ()

Time to Maturity (T)

Riskfree Rate (Rf)

Dividends (Div)