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1、Chapter 24Derivatives and Risk Management1Topics in ChapternRisk management and stock value maximization. nDerivative securities.nFundamentals of risk management.nUsing derivatives to reduce interest rate risk.2Do stockholders care about volatile cash flows?nIf volatility in cash flows is not caused
2、 by systematic risk, then stockholders can eliminate the risk of volatile cash flows by diversifying their portfolios. nStockholders might be able to reduce impact of volatile cash flows by using risk management techniques in their own portfolios.3How can risk management increase the value of a corp
3、oration?nRisk management allows firms to:nHave greater debt capacity, which has a larger tax shield of interest payments.nImplement the optimal capital budget without having to raise external equity in years that would have had low cash flow due to volatility.(More. )4Risk management allows firms to
4、:nAvoid costs of financial distress.nWeakened relationships with suppliers.nLoss of potential customers.nDistractions to managers.nUtilize comparative advantage in hedging relative to hedging ability of investors.(More. )5Risk management allows firms to (Continued):nReduce borrowing costs by using i
5、nterest rate swaps.nExample: Two firms with different credit ratings, Hi and Lo:nHi can borrow fixed at 11% and floating at LIBOR + 1%.nLo can borrow fixed at 11.4% and floating at LIBOR + 1.5%.(More. )6Hi wants fixed rate, but it will issue floating and “swap” with Lo. Lo wants floating rate, but i
6、t will issue fixed and swap with Hi. Lo also makes “side payment” of 0.45% to Hi.Hi LoCF to lender-(LIBOR+1%)-11.40%CF Hi to Lo-11.40%+11.40%CF Lo to Hi+(LIBOR+1%)-(LIBOR+1%)CF Lo to Hi+0.45%-0.45%Net CF-10.95%-(LIBOR+1.45%)(More)7Risk management allows firms to:nMinimize negative tax effects due to
7、 convexity in tax code.nExample: EBT of $50K in Years 1 and 2, total EBT of $100K,nTax = $7.5K each year, total tax of $15.nEBT of $0K in Year 1 and $100K in Year 2,nTax = $0K in Year 1 and $22.5K in Year 2.8What is corporate risk management?nCorporate risk management is the management of unpredicta
8、ble events that would have adverse consequences for the firm.9Different Types of RisknSpeculative risks: Those that offer the chance of a gain as well as a loss.nPure risks: Those that offer only the prospect of a loss.nDemand risks: Those associated with the demand for a firms products or services.
9、nInput risks: Those associated with a firms input costs.(More. )10nFinancial risks: Those that result from financial transactions.nProperty risks: Those associated with loss of a firms productive assets.nPersonnel risk: Risks that result from human actions.nEnvironmental risk: Risk associated with p
10、olluting the environment.nLiability risks: Connected with product, service, or employee liability.nInsurable risks: Those which typically can be covered by insurance.11What are the three steps of corporate risk management?nStep 1. Identify the risks faced by the firm.nStep 2. Measure the potential i
11、mpact of the identified risks.nStep 3. Decide how each relevant risk should be dealt with.12What are some actions that companies can take to minimize or reduce risk exposures?nTransfer risk to an insurance company by paying periodic premiums.nTransfer functions which produce risk to third parties.nP
12、urchase derivatives contracts to reduce input and financial risks.(More. )13nTake actions to reduce the probability of occurrence of adverse events.nTake actions to reduce the magnitude of the loss associated with adverse events.nAvoid the activities that give rise to risk.14What is financial risk e
13、xposure?nFinancial risk exposure refers to the risk inherent in the financial markets due to price fluctuations.nExample: A firm holds a portfolio of bonds, interest rates rise, and the value of the bonds falls.15Financial Risk Management ConceptsnDerivative: Security whose value stems or is derived
14、 from the value of other assets. Swaps, options, and futures are used to manage financial risk exposures.(More. )16nFutures: Contracts which call for the purchase or sale of a financial (or real) asset at some future date, but at a price determined today. Futures (and other derivatives) can be used
15、either as highly leveraged speculations or to hedge and thus reduce risk.17nHedging: Generally conducted where a price change could negatively affect a firms profits.nLong hedge: Involves the purchase of a futures contract to guard against a price increase.nShort hedge: Involves the sale of a future
16、s contract to protect against a price decline in commodities or financial securities. (More. )18nSwaps: Involve the exchange of cash payment obligations between two parties, usually because each party prefers the terms of the others debt contract. Swaps can reduce each partys financial risk.19How can commodity futures markets be used to reduce input price risk?nThe purchase
