What is risk management for organisations?
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
What are some internal risk management strategies?
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
What are some external risk management strategies?
Use derivative products
What is the effective risk management acronym?
Identifying exposures
Quantifying the exposure
Evaluating the exposures
Managing the exposures
What is some background on derivatives?
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.
What has changed in derivative markets over the last 30 years?
Substantially grown in size and variety because of deregulation, advances in tech and volatility in some markets.
Who are the users of derivative markets?
- 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.
- use the market to lock in a future price and hence
- Speculators
- using the market to bet on a price change.
- have no underlying position in the asset.
- Arbitrageurs
- trade on mispricing between the derivatives
and spot markets or between different
derivative contracts to make a riskless profit.
- trade on mispricing between the derivatives
What are some common risks to hedge in derivative markets?
- Commodity price risk
- Interest rate risk
- Currency risk
- Share market risk
Difference between forward and futures contract?
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.
What’s one important and two confusing aspects of futures?
It’s a zero sum game.
- you can sell first and buy later
- with cash settlement the asset is never exchanged
What are 3 types of financial futures?
Bank Bills
Commonwealth Bond Futures
Share Price Index futures
Who are the uses of futures markets?
Hedgers - worried about fall - sell
- worried about rise - buy
2. speculators
3. arbitrageurs
What is some background on options?
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
Who are the users of options markets?
1. Hedgers worried about fall - buy put options worried about rise - buy call options 2. speculators 3. arbitrageurs
What are 6 variables relevant to options share price?
Share Price (S)
Exercise Price (X)
Standard Deviation of Return of Share ()
Time to Maturity (T)
Riskfree Rate (Rf)
Dividends (Div)
