Ch.16 Financial Risk Management

Question 1

What are the three major categories of financial risk?

Answer 1

1. Interest Rate Risk
2. FX risk
3. Commodity Price Risk

Question 2

What are the three types of foreign exchange (FX) risk?

Answer 2

1. Economic Risk
2. Transaction Risk
3. Translation Risk

Question 3

Discuss the concepts of active hedging, speculation, and arbitrage.

Answer 3

• Hedging, much like buying insuranace
• Speculation, Buying with an anticipation of gain
• Arbitrage, Gains without taking risk

Question 4

What are the benefits of financial risk management?

Answer 4

• Less volatility for better cash flows.

Question 5

What is a swap agreement?

Answer 5

• 2 parties swap cash flows usually between different currencies. Also used for interest rate advantages.

Question 6

What is the difference between a call option and a put option?

Answer 6

• Call, you expect the price to rise and put you sell the underlying asset…while expecting the price to fall.

Question 7

When are option contracts normally exercised?

Answer 7

-European, on delivery date. In America, it can be anytime before expiration date.

Question 8

Discuss the objectives of global treasury management.

Answer 8

• Manage Cash resources that is consistent with the strategic goals.

Question 9

What are the two basic FX markets?

Answer 9

1. Spot Market

2. Forward Market

Question 10

What are forward points?

Answer 10

The difference between two countries short term money market interest rates at the time the trade is executed.

Question 11

What is a currency swap?

Answer 11

• Swapping currencies to manage FX exposure

Question 12

Explain a forward rate agreement (FRA).

Answer 12

• Agreement to lock in a rate for the promise to buy that currency at the present rate in a future period

Question 13

What are interest rate futures?

Answer 13

• contracts on asset whose price is dependent on future interest rates T-Bills

Question 14

What is an interest rate collar?

Answer 14

• Buying a cap and a floor to hedge against interest rate exposure.

Question 15

What are the disclosures required by ASC Topic 815?

Answer 15

• discussion of the company’s objectives and strategies for using derivatives
• current fair market value of the derivatives
• Where they are located
• credit related features of the derivatives

Question 16

Compare implicit and explicit FX risk.

Answer 16

• Implicit is volatile to the change in exchange rates

- explicit is the fx rate between the transaction occurring and settling

Question 17

Discuss the challenges for global companies operating in emerging markets.

Answer 17

• Currency exposure, FX related challenges that create financial uncertainty

Question 18

What are exotic currencies?

Answer 18

• currencies in emerging markets(not as well established or commonly traded)