5. equity price risk
• risk resulting from holding equities or assets with
performance tied to equity prices
• faced by all organizations possessing or issuing
equities
• main risks include:
– equity price risk
– systematic risk
6. interest rate risk
• risk resulting from volatility of interest rates
• faced by all companies with borrowings (affecting
cost of funds)
– loan with fixed rate of interest
– loan with floating (variable) rate of interest
• impact depends on company structure / relation of:
– capital and debt (leverage ratio)
– short and long term debt
– fixed and floating rate debt
7. foreign exchange rate risk
• risk resulting from change in the exchange rate of one
currency against another
• faced by all organizations involved in foreign exchange or
utilizing commodities denominated in other currency
• fx rates risk arise mainly from:
– transaction risk exposure
– translation risk (affecting the value of balance sheet items
incl. AP and liabilities)
– reporting translation risk (from the operating currency into
a reporting currency)
– strategic exposure - based on organization’s competitive
position of its local currency
8. commodity price risk
• risk resulting from commodity prices rising or falling
• faced by all organizations that produce or purchase
commodities
• main commodity risks include:
– commodity price risk
– commodity quantity risk
– cost of carry risk (financing, storage, transportation)
– special risks (e.g. shortage)
10. derivatives
• is an asset whose performance is based on the
behaviour of an underlying asset (commonly called
underlying)
• main market risks could be mitigated using
derivatives contracts
• most common derivatives include:
– forward contracts
– future
– swap
– option
11.
12. forward
• non-standardized contract between two parties to
buy or sell an asset at a future date at a price agreed
today
• differs from spot contract which is to buy or sell an
asset at the moment at the current price
• the difference between the spot and the forward
price is the forward premium or forward discount
• deliverable or non-deliverable (difference payment)
13. main types of forwards
• repurchase agreement (repo) - the sale of securities
together with an agreement for the seller to buy
back the securities at a later date
• forward rate agreement (FRA) - contract where
party pay/receive the difference between a agreed
interest rate and the rate which actually eventuates
at agreed future date
• currency forward
• commodity forward contract
14. forward example
• Company A (coffee maker) wants to buy a 10 tons of raw
coffee from Company B (producer) in one year time.
• Current spot price of 1 ton is 90,000 USD. Forward contract of
10 tons is agreed with forward price 950,000 USD.
• In one year time:
– what will be profit/loss of Company A if coffee price will be the same
– what will be profit/loss of Company A if coffee price will increase by
10%
15. future
• standardized contract between two parties to
exchange a specified asset of standardized quantity
and quality at a future date at a price agreed today
• future contracts are traded on a futures exchanges
• used for commodities as well as currencies,
securities or referenced items such as stock indexes
16. how future works
• exchange requires both parties to put up an initial
amount of cash on account - the margin
• as margin is usually smaller than notional amount it
gives possibility of leverage
• daily valuation to agreed price - difference is paid
from one party to another party account
• if the margin account goes below a certain value
then a margin call is made
17. swap
• non-standardized derivative contract in which
counterparties exchange cash flows (payments) for
financial instruments
• swap may be direct contract between two companies
or with third party acting as intermediary
• swap agreement defines the dates when the cash
flows are to be paid and the way they are calculated
• cash flows are calculated over a notional principal
amount - usually not exchanged between
counterparties
19. main types of swaps
• interest rate swap - exchange of fixed and floating
interest rate
• currency swap - exchange principal and interests of
loan in one currency on equivalent of another
currency
• commodity swap - exchange of spot and fixed price
of underlying commodity
• credit default swap (CDS) - exchange of credit
default
20. swap example (I)
• company A with AAA credit rating
– fixed rate 10.00%
– floating rate LIBOR + 0.30%
– seeks floating financing
• company B with BBB credit rating
– fixed rate 11.20%
– floating rate LIBOR + 1.00%
– seeks fixed financing
• total financing cost
= LIBOR + 0.30% + 11.20% = LIBOR + 11.50%
21. swap example (II)
• two companies enters swap contract:
– company A issue debt for 10.00%
– company B issue debt for LIBOR + 1.00%
• total financing cost
= 10.00% + LIBOR + 1.00% = LIBOR + 11.00%
= total gain = 0.50%
• companies swap its payments (equal distribution of gain):
– company A receive 10.00% to repay debt and pays LIBOR + 0.05%
– company A net gain is (LIBOR + 0.30%) - LIBOR + 0.05% = 0.25%
22. swap example (III)
• in case bank act as intermediary swap contract will have bank
spread as its cost
23. swap exercise
• company A
– fixed rate 8.00%
– floating rate EURIBOR + 1.00%
– seeks floating financing
• company B with BBB credit rating
– fixed rate 10.00%
– floating rate EURIBOR + 2.00%
– seeks fixed financing
24. swap
– what will be total gain from swap contract ?
– what kind of debt each company should issue and what
will be its cost ?
– in case of swap how much each company will have to pay
into the intermediary bank ?
– what will be net gain of each company (equal distribution
of gain) if bank swap spread is 0.40% ?
25. options
• options are contracts that give the owner the right,
but not the obligation, to buy or sell an asset
– in case of buy - call option
– in case of sell - put option
