FINA 2710 Chapter Notes - Chapter 26: Downside Risk, Interest Rate Cap And Floor, Interest Rate Derivative
2 Apr 2017
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Volatility in day-to-day business factors often leads to volatility in cash flows and returns. If a firm can reduce that volatility, it can reduce its business risk. Hedging reducing a firm"s exposure to price/rate fluctuations. Instruments have been developed to hedge the following types of volatility: interest rate, exchange rate, commodity rate. Financial engineering the use of existing financial instruments to create new ones that allow firms to hedge against specific risks. Derivative a financial instrument that represents a claim to another financial asset: derives its value from that other asset. The process of financial engineering often involves creating new derivative securities or combining existing derivatives to accomplish the firm"s hedging goals. Debt is a key component of a firm"s capital structure. Interest rates are a key component of a firm"s cost of capital. Interest rates can fluctuate dramatically in short periods of time.
