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FIN 401 (25)
Chapter 24

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Ryerson University
FIN 401
Scott Anderson

Chapter 24 FIN401 24.1 Hedding and price volatility - hedging is where we try to make a firm less vulnerable to changes in the price or rate - derivative securities are an asset that represents a right to another financial asset 24.2 Managing financial risk - to be able to control financial risk, we must determine the types of changes in the price that will have a large impact on the value of a firm The risk profile - risk profile is a graph that shows how the value of a firm is affected by changes in the price or rate Reducing risk exposure - partnering with a firm would help reduce through contracts: set a fixed price ahead of time, cannot be affected - it Is not possible to create a flat risk profile, but we can reduce risk - the goal is to reduce the risk to more manageable levels which will flatten the risk profile - two categories: short run- causes temporary changes are the first. Long run is where there are more permanent changes Hedging short run exposure - short run changes are caused by unexpected changes or events that take place - Short run changes can ruin businesses in the short run, in the long run they adjust therefore they’ll be fine - transactions exposure is where the firm becomes vulnerable in the short run from the need to buy or sell at unexpected price or rates in the future Cash flow hedging: a cautionary note - directly hedging the value of the firm is not practical, the firm will try to guarantee future cash flows are accurate - if the firm is able to avoid expensive disruptions, then cash flow heding will act to hedge the value of the firm but the linkage is indirect - hedging activities should be done on a centralized basis Hedging long term exposure - changes in the price can be longer run and more permanenet, which results from changes in the economics of a business - economic exposure is long term financial risk that comes from permanent changes in prices or other economic fundamentals - long term exposure Is more difficult to hedge on a permanent basis - contract approach would not work as eventually trying to keep a fixed price over a long period of time would be a determint to one party Conclusion - by managing financial risks the firm is able to protect itself from transitory price fluctuations and the firm is able to have time to adjust to changes in market conditions - In the long run, a business can generate a profit or become bankrupt, regardless of how much effort went into hedging 24.3 Hedging with forward contracts Forward contracts: the basics - forward contracts like the name implies is where two parties agree upon a price today that will be applied to the sale of an asset. - settlement date is where the goods are moved from one party to the other - in a forward contract, the buyer is responsible for delivery and paying for the goods, sellers are responsible for making the delivery and
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