Risk management

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What is corporate risk management?

Corporate risk management relates

to the management of unpredictable
events that would have adverse
consequences for the firm.

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Why is corporate risk management
important to all firms?

All firms face risks, but the lower

those risks can be made, the more
valuable the firm, other things held
constant. Of course, risk reduction
has a cost.

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What are the three steps of
corporate risk management?

Step 1. Identify the risks faced by the

firm.
Step 2. Measure the potential impact of
the identified risks.
Step 3. Decide how each relevant risk
should be handled.

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What are some actions that
companies can take to minimize
or reduce risk exposure?

Transfer risk to an insurance company

by paying periodic premiums.
Transfer functions that produce risk to
third parties.
Purchase derivative contracts to
reduce input and financial risks.
(More...)

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Take actions to reduce the

probability of occurrence of
adverse events.
Take actions to reduce the
magnitude of the loss associated
with adverse events.
Avoid the activities that give rise
to risk.

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What is a financial risk exposure?

Financial risk exposure refers to the

risk inherent in the financial markets
due to price fluctuations.
Example: A firm holds a portfolio of
bonds, interest rates rise, and the
value of the bonds falls.

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Financial Risk Management Concepts

Derivative: Security whose value stems or

is derived from the values of other assets.
Swaps, options, and futures are used to
manage financial risk exposures.

Futures: Contracts that 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 either as highly leveraged speculations
(More...)
or to hedge and thus reduce risk.

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Hedging: Generally conducted where a

price change could negatively affect a
firms profits.

Long hedge: involves the purchase

of a futures contract to guard against a
price increase.

Short hedge: involves the sale of a

futures contract to protect against a
price decline in commodities or
financial securities.

(More...)

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Swaps: 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.

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How can commodity futures markets
be used to reduce input price risk?

The purchase of a commodity futures

contract will allow a firm to make a
future purchase of the input at
todays price, even if the market price
on the item has risen substantially in
the interim.

FUTURE
Contract to buy or sell a stated commodity or financial
claim at a specified price at some futures, specified
times
A contract to make or take delivery of a product in the
future, at a price set in the present
In formalized futures and options trading on
exchanges, standardized agreements specify price,
quantity, and month of delivery
Started in agriculture, but have expanded to a wide
range of products

OPTION
Sebuah hak untuk membeli atau menjual produk
turunan di waktu tertentu dengan harga yang telah
disepakati dimuka. Karena sifatnya ini adalah hak,
maka pemilik (pembeli) opsi berhak untuk
menggunakannya atau tidak. Sementara bagi penjual
opsi terikat kewajiban untuk melaksanakan transaksi
dalam hal pemilik opsi ingin menggunakan haknya
dimaksud. Pemilik opsi biasanya hanya akan
menggunakan haknya dalam kondisi yang
menguntungnya.

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What is an option?

An option is a contract that gives its

holder the right, but not the
obligation, to buy (or sell) an asset at
some predetermined price within a
specified period of time.

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What is the single most important
characteristic of an option?

It does not obligate its owner to

take any action. It merely gives the
owner the right to buy or sell an
asset.

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Option Terminology

Call option: An option to buy a

specified number of shares of a security
within some future period.
Put option: An option to sell a specified
number of shares of a security within
some future period.
Exercise (or strike) price: The price
stated in the option contract at which
the security can be bought or sold.

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Option price: The market price of

the option contract.
Expiration date: The date the
option matures.
Exercise value: The value of a call
option if it were exercised today =
Current stock price - Strike price.

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Covered option: A call option

written against stock held in an
investors portfolio.
Naked (uncovered) option: An
option sold without the stock to
back it up.
In-the-money call: A call option
whose exercise price is less than
the current price of the under-lying
stock.