68 Derivative Benefits

Question 1

Derivative benefits

Answer 1

1) Transfer/manage existing risk
2) Easier to get short position
3) Lower transactions cost compared to cash market
4) Less cash required/higher leverage
5) Greater liquidity
6) Improve efficiency of market prices

Question 2

Derivative benefits - information

Answer 2

1) Expected volatility
2) Estimates of future prices
3) Expected changes in interest rates

Question 3

Basis risk

Answer 3

Underlying mismatch with hedged risk

Question 4

Derivative risks

Answer 4

1) Liquidity risk
2) Counterparty credit risk
3) Systemic risks

Question 5

Cash flow hedge

Answer 5

Fixed rate payer swap to reduce uncertainty about future floating rate interest payments

Question 6

Fair value hedge

Answer 6

Floating rate payer swap to offset changes int he balance sheet

Question 7

Net value hedge

Answer 7

Hedging the value of a foreign subsidiary’s equity on a parent’s balance sheet