FIN80018-Derivatives and Risk Management
Assume that your team has recently been appointed as the “Financial Risk Management” team of your organisation. For this purpose, select a company of your choice (please sign up to a group/company on Canvas) and assess how well the company manages its risk by addressing the following issues. Your team has been requested to prepare a report to present to the board.
(a) Identify the primary financial risks (please limit the financial risks to what is taught in this unit) your company is exposed to. For this purpose, you need to consider the income statement and balance sheet of the company. In this section, you MUST discuss the outlook for each underlying variable, and identify whether it will present a risk to the firm. You need to provide adequate justification for your responses.
N.B: Please note that if you discuss any risks that are not taught in this unit and if any of these explanations/analyses are incorrect you will be penalised. Therefore, it is strongly recommended that you limit the risks to what is taught in this unit.
(b) Make firm recommendations on whether to hedge all, part or none of the financial risk exposures that you identified in part (a) above. You MUST provide some explanation for each of your recommendations. You need to explain the reasons for suggesting this strategy. (You are not required to specify the type of derivative to be used to hedge in response to this question).
(c) To make recommendations on which derivative instruments (for example, options, futures etc.) to use to implement any hedges that you have recommended in part (b) above. Once again, you MUST explain your recommendations. This means that you will need to provide very well researched and fully explained reasons for your responses to part (b). However, it is advised that you make at least some hedge recommendations to make responses to parts (c) and (d) more meaningful]. You are NOT required to propose details of how to implement your hedge recommendations in this part – this is to be done in part (d).
(d) To propose, in accordance with each of your recommendations in (c) above, specific hedging strategies which require you to describe the following
i. the exposures to be hedged,
ii. what percentage proportion of the exposure is to be hedged,
iii. which derivative(s) are to be used to hedge each exposure,
v. the number of derivative contracts for each hedge,
v. the delivery months for each derivative, and
vi. the prices at the time of making the recommendation - futures prices, option strike prices, total premium costs (including an explanation of the choice of strike price(s)) (you will need to research this- use actual data).
It is best to limit your hedging strategies to what is taught in this unit. You may explain other strategies that are not taught in this unit. However, any incorrect explanations would be penalised
For part (d) you may assume a hedge horizon 6 months and you can use futures or options with the relevant expiration date for hedging
Also, in part (d) if you recommend option strategies you may also wish to consider strategies that require the ‘purchase and sale’ of two different options (e.g. an option spread or combination strategy) to reduce the cost of the option strategy.