Tài chính doanh nghiệp - Chapter 18: An introduction to risk management And derivatives

Chapter 18An introduction to risk management And derivativesLearning objectivesUnderstand the nature and importance of risk and risk management, especially operational and financial risk exposuresConstruct and analyse a structured risk management processExamine the fundamentals of futures contractsReview the operation of forward exchange contracts and forward rate agreementsUnderstand the nature and versatility of options contractsConsider the structure of an interest rate swap and a cross-currency swapChapter organisation18.1 Understanding risk18.2 The risk management process18.3 Futures contracts18.4 Forward contracts18.5 Option contracts18.6 Swap contracts18.7 Summary18.1 Understanding riskRisk—the possibility or probability of something occurring that is unexpected or unanticipatedCategories of riskOperational riskFinancial risk(cont.)18.1 Understanding risk (cont.)Operational riskExposure that may impact on the normal commercial functions of a business, affecting its operational and financial performance; e.g.:technologyproperty and equipmentpersonnelcompetitorsnatural disastersgovernment policysuppliers and outsourcingCan be managed through the use of real options(cont.)18.1 Understanding risk (cont.)Financial riskExposures that result in unanticipated changes in projected cash flows or the structure and value of balance-sheet assets and liabilities; e.g.:interest rate riskforeign exchange riskliquidity riskcredit riskcapital risk(cont.)18.1 Understanding risk (cont.)Financial risk (cont.)Relationships between risks can result in one risk impacting on another riskDirect risk—the initial risk event that impacts on the operational or financial position of an organisationConsequential risks—exposures that eventuate as a result of an initial direct risk eventChapter organisation18.1 Understanding risk18.2 The risk management process18.3 Futures contracts18.4 Forward contracts18.5 Option contracts18.6 Swap contracts18.7 Summary18.2 The risk management processEffective management of risk exposures requires a structured risk management process Although the range of risks varies by organisation, one such model is:identify operational and financial risk exposuresanalyse the impact of the risk exposuresassess the attitude of the organisation to each identified risk exposureselect appropriate risk management strategies and productsestablish related risk and product controlsimplement the risk management strategymonitor, report, review and audit(cont.)18.2 The risk management process (cont.)Identify operational and financial risk exposuresRequires full understanding of the business, including operations, personnel, competitors, regulators, legislative requirements, stakeholders, cash flows and balance sheet structureAlso need to understand interrelationships and causal links between the above categoriesAnalyse the impact of the risk exposuresA business impact analysis is used to document each risk exposure and measure the operational and financial impacts should the risk event occurNeed to consider both quantitative and qualitative risks(cont.)18.2 The risk management process (cont.)Assess the attitude of the organisation to each identified risk exposureNot all risks will be mitigated or removedThe risks to be avoided, controlled, transferred or retained should be documentedSelect appropriate risk management strategies and productsAn integrated process to analyse the risk management options availableGenerally, several risk management strategies available, the choice between them to be subject to cost–benefit analysisAll risk management processes and strategies should be periodically audited (cont.)18.2 The risk management process (cont.)Establish related risk and product controlsEnsure adequate controls established, documented and circulated among personnelThese include procedural controls and system controlsProcedural controls document risk management products that can be used by the organisationSystem controls cover all electronic product delivery and information systems relating to the identification, measurement, management and monitoring of risk management(cont.)18.2 The risk management process (cont.)Implement the risk management strategyObtain written authority to proceed with implementationCheck that time lags between the commencement of this process and the implementation of the strategy have not impaired the effectiveness of the strategyRisk strategies are developed for different planning periodsMonitor, report, review and auditAs risk management is ongoing, the strategies must be continuously monitored to ensures they achieve the expected risk management objectives and outcomesChapter organisation18.1 Understanding risk18.2 The risk management process18.3 Futures contracts18.4 Forward contracts18.5 Option contracts18.6 Swap contracts18.7 Summary18.3 Futures contractsAn agreement between two parties to buy, or sell, a specified commodity or financial instrument at a specified date in the future at a price determined todayAn exchange traded contract where standardised contracts are traded in a formal market(cont.)18.3 Futures contracts (cont.)Examples include:A fund manager holding shares who is concerned the price may fall before they are soldAn investor concerned that share prices may rise before they are purchasedStrategy involves carrying out an initial transaction in the futures market that corresponds with the transaction to be conducted in the physical market at a later date (see Figure 18.1, next slide)(cont.)18.3 Futures contracts (cont.)(cont.)18.3 Futures contracts (cont.)Relevant termsClearing house—records transactions conducted on an exchange and facilitates value settlement and transferInitial margin—deposit lodged with clearing house to cover adverse price movements in a futures contractMarked-to-market—the periodic repricing of an existing contract to reflect current market valuationsMaintenance margin call—the top-up of an initial margin to cover adverse futures contract price movementsChapter organisation18.1 Understanding risk18.2 The risk management process18.3 Futures contracts18.4 Forward contracts18.5 Option contracts18.6 Swap contracts18.7 Summary18.4 Forward contractsA financial instrument designed mainly to manage specified risksOffered over the counter by financial institutionsTherefore, more flexible than highly standardised exchange-traded products like futures, as the terms and conditions of a forward contract, such as amount and timing of the contract, can be negotiatedTwo main types1. Forward rate agreements (FRAs)2. Forward foreign exchange contracts(cont.)18.4 Forward contracts (cont.)1. Forward rate agreements (FRAs)An over-the-counter product used to manage interest rate risk exposuresAllows a borrower to manage future interest rate risk exposure by locking in an interest rate today that will apply at a specified future dateIs given effect by one party to the contract compensating the other party if the reference rate is different from the agreed rateRelevant termsFRA agreed rate—the fixed interest rate stipulated in the FRA at the start of the contractFRA settlement date—the date when the FRA agreed rate is compared with the reference rate to calculate the compensation amountFRA contract period—the term of the interest rate protection built into the FRA(cont.)18.4 Forward contracts (cont.)(cont.)18.4 Forward contracts (cont.)2. Forward foreign exchange contractsAlso known as a forward exchange contract; locks in an exchange rate today for delivery of foreign currency at a specified future dateExample, an Australian company may be importing goods from overseas and the company will need to pay USD1 million in three months’ timeChapter organisation18.1 Understanding risk18.2 The risk management process18.3 Futures contracts18.4 Forward contracts18.5 Option contracts18.6 Swap contracts18.7 Summary18.5 Option contractsAn option gives the buyer the right, but not the obligation, to buy or sell a specified commodity or financial instrument at a predetermined price (exercise or strike price), on or before a specified date (expiration date)Types of optionsCall optionsGive the option buyer the right to buy the commodity or instrument at the exercise pricePut optionsGive the buyer the right to sell the commodity or instrument at the exercise price(cont.)18.5 Option contracts (cont.)An option will only be exercised if it is in the buyer’s best interests; i.e.:A buyer will not exercise the right to sell if the physical market price is above the exercise price of the optionA buyer will not exercise the right to buy if the physical market price is below the exercise price of the option contract at expiration date Options can be exercised either:only on expiration date (European option); orany time up to expiration date (American option)(cont.)18.5 Option contracts (cont.)PremiumThe price paid by an option buyer to the writer (seller) of the optionExercise price or strike priceThe price specified in an options contract at which the option buyer can buy or sell(cont.)18.5 Option contracts (cont.)Call option profit and loss payoff profiles(cont.)18.5 Option contracts (cont.)Put option profit and loss payoff profiles (cont.)Chapter organisation18.1 Understanding risk18.2 The risk management process18.3 Futures contracts18.4 Forward contracts18.5 Option contracts18.6 Swap contracts18.7 Summary18.6 Swap contractsAn over-the-counter financial product allowing parties to enter into a contractual agreement to exchange cash flowsIntermediated swapA party enters into a swap with a financial intermediaryDirect swapTwo parties enter into a swap with each other without using a financial intermediaryTwo main types of swap contractsInterest rate swaps Cross-currency swaps(cont.)18.6 Swap contracts (cont.)1. Interest rate swapsThe exchange of interest payments associated with a notional principal amountNotional principal amount—the underlying amount specified in a contract that is used to calculate the value of the contractVanilla swap—a swap of a series of fixed interest rate payments for floating interest rate paymentsBasis swap—a swap of a series of two different reference rate interest paymentsSwap rate—the fixed interest rate specified in a swap contract(cont.)18.6 Swap contracts (cont.)(cont.)18.6 Swap contracts (cont.)(cont.)18.6 Swap contracts (cont.)2. Cross-currency swapsTwo parties, such as a bank and a company, exchange debt denominated in different currenciesInterest payments are exchangedPrincipals exchanged at beginning of agreement and then re-exchanged at conclusion of agreement, usually at the same exchange rateExample:If the swap is an AUD-USD contract based on USD1 million and an exchange rate set at AUD/USD0.9245, at the start of the contract one party would exchange USD1 million for AUD1081 665.76At each future interest payment date, interest payments would be calculated using the same exchange rate; i.e. AUD/USD0.9245Finally, at the swap completion date, the original AUD and USD principal amounts would be re-exchanged(cont.)18.6 Swap contracts (cont.)Chapter organisation18.1 Understanding risk18.2 The risk management process18.3 Futures contracts18.4 Forward contracts18.5 Option contracts18.6 Swap contracts18.7 Summary18.7 SummaryRisk can be categorised as operational and financial riskThe risk management process involves a number of stepsA futures contract is an agreement between two parties to buy or sell a specified commodity or instrument at a specified future date at a price specified todayA forward contract is a financial instrument designed to manage specified riskTwo forward contracts are forward rate agreements (FRAs) and forward exchange contracts(cont.)18.7 Summary (cont.)An option contract gives the buyer the right but not the obligation to buy or sell a specified commodity or financial instrument at a specified price on or before a specified dateSwaps facilitate the exchange of specified cash flowsInterest rate swaps are used to manage interest rate riskCurrency swaps are used when an interest rate swap involves borrowing in different currenciesAllow the management of interest rate and FX risk exposureCurrency swaps differ from interest rate swaps in that the principal amounts raised by the two borrowers are swapped at the commencement and re-exchanged at the end of the agreement