Using Derivatives to Manage

Risks, Challenges Faced by

Corporates Today

Presented By Sayali Kotwal

112

Vruddhi Naik

117

Akanksha Omargekar

118

Kruti Shah

128

Prathamesh Shirolkar

133

Akshatha Suvarna

137

Introduction to derivatives
market

A derivative is a financial instrument whose value is derived from

the value of another asset, known as underlying asset.

Derivatives can be bought or sold in two ways:

Over-the-counter(OTC)
(OTC derivatives are contracts that are made privately between
parties)

Exchange Traded
(Derivatives that trade on an exchange are standardized contracts)

Investors typically use derivatives for three reasons:

tohedgea position
to increase leverage
to speculate on an asset's movement

Introduction to derivatives market

There are three basic types of contracts:
1. Options

Long Call

Long Put

Short Call

Short Put

2. Swaps

Interest Rate Swaps

Currency Swaps

Commodity Swaps

3. Futures/Forward contracts

Challenges Faced in Derivative

Markets

Lack of Economies of Scale

Strengthening the Centralized Clearing Parties

Commodity Options

Cash vs. Physical Settlement

Competition of OTC derivatives with the Exchange-traded

Derivatives

The Regulator

Issues for Market Stability and Development

Increased Off-Balance Sheet Exposure of Indian Banks

Tax and Legal bottlenecks

GE - Lufthansa

On 1st January 2003, General electric entered into a contract

to sell turbine blades to Lufthansa airlines.

GE will receive the payment of 10 million on 31st December,

2003 in terms of Euros.

In this case GE is exposed to - $ exchange

rate fluctuations i.e. transactional exposure.

Strategies to Overcome Transactional Exposure

1. Enter into a forward contract

(example: spot rate on Jan01 : 1 = $ 1 and spot rate on Dec31 : 1 =
$0.957)

2. Risk Shifting
(Ask Lufthansa to pay in USD. But Lufthansa will also consider forward
rate)

Strategies to Overcome
Transactional Exposure
3. Pricing Decision
(If GE wants to protect $10 mn revenue and forward rate is $0.957/ then
they must quote 10/9.57 = 10.45 mn)

4. Money Market Hedging

(e.g: spot rate : 1 = $ 1 and forward rate : 1 = $0.957
let interest rate is 15% and $ interest rate is 10%)

Jan 01

Dec 31

Currenc
y

Amount

Borrow

8.7 mn

Discounted at 15%

Invest

8.7 mn

Since spot rate is 1 = $ 1

Repay

10 mn

As you will receive from Lufthansa

Receive

9.57 mn

Since you will get back 8.7 mn at

10% interest

Indian airlines company

Risks:

Price fluctuations in the international oil market

Dollar price fluctuation

Thus, In the international market, both commodity hedging and

currency hedging go hand in hand.

if the airlines do not know at what price they are going to buy fuel
for their aircrafts 3 months later

So its difficult to determine price of ticket for advance booking

Thus, its better to do hedging

By this they will reduce their transaction cost, and can also
determine the costs of running the flights and thus calculate the
cost of a ticket

Thank
You