Define each of the following terms:
- a. Derivatives
- b. Enterprise risk management
- c. Financial futures; forward contract
- d. Hedging; natural hedge; long hedge; short hedge; perfect hedge; symmetric hedge; asymmetric hedge
- e. Swap; structured note
- f. Commodity futures
a)
To define: The term derivatives.
Explanation of Solution
An indirect claim security whose value (in whole or in part) is derived from the market price of the other securities traded in the market is known as derivative.
The market in which securities with derived values are traded is called derivative market. It comprises instruments like options (call or put options), interest rate futures, swaps, commodity futures and exchange rate futures.
b)
To define: The term enterprise risk management.
Explanation of Solution
Enterprise risk management is the process designed by the top managerial authorities in an enterprise by which potential uncertain events that might impact the enterprise and manage risk to be within its risks appetite to offer reasonable guarantee regarding the achievement of enterprise objectives.
c)
To define: The financial future contract and forward contract.
Explanation of Solution
Future contract are the contracts by which buyer or seller can buy or sell the financial assets in the future specified date at the prices decided today. This is used by the investors if the estimated future value of the financial assets is going to increase or to decrease to earn profit and reduce their losses.
Futures are available for Treasury bill, CDs, bonds, currencies, stock indices, E dollar and treasury notes.
The forward contracts are quite similar to future contracts, but the main difference between them is that actual delivery takes place under forward contract whereas under future contracts actual delivery of goods does not takes place. Under futures, virtual delivery is made to the investors’ account.
d)
To define: The terms natural hedge, long hedge, short hedge, perfect hedge, symmetric hedge and asymmetric hedge.
Explanation of Solution
A transaction is said to be hedging by which firm tries to reduce the risk of damages caused due to the fluctuations in interest rates, exchange rates and stock prices.
Natural hedging: A transaction by which the risk of both the counterparties is reduced, this transaction is known as natural hedging.
Long hedge: It means the purchase of future contract as investor believes that the prices of the financial assets will increase whereas the short hedge is to sell the future contract with anticipation of fall in the future prices.
Perfect hedge: The transaction which completely offsets the gain or loss on the non-hedged position is called perfect hedge.
Symmetric hedge: When the upward and downward prices changes can be protected by using a transaction that hedge is known as symmetric hedge. For instance, reduce risk by using future contracts.
Asymmetric hedge: An asymmetric hedge covers only one-directional changes in price more than other. For instance, options are used to cover asymmetric hedges.
e)
To define: The term swaps and structured notes.
Explanation of Solution
Swaps: Swaps is an interchanging of cash payment obligations. It used by the firm so that they can reduce their risk as this contract allows the firm to exchange the risk or debt of another party whose debt contract terms are more attractive.
Structured note: A debt obligation resulting from another debt obligation which allows risk dividing of risks to give investors whatever they desire for.
f)
To define: The term commodity futures.
Explanation of Solution
Commodity futures contracts: Commodity futures contracts are futures contracts that permits the trading of commodities such as oilseed, gold or other metal, livestock, fiber, meats, wood, and grains. There is a list of commodities for which futures are traded.
Want to see more full solutions like this?
Chapter 24 Solutions
Intermediate Financial Management
- Discuss the following operating hedge strategies 1. Risk Shifting 2. Price Adjustment clauses 3. Exposure nettingarrow_forwardDefine each of the following terms: c. Financial futures; forward contractarrow_forwardDescribe forwards, futures, and swaps. What are the features of each type of derivative and how are these derivatives used to hedge risk or speculate?arrow_forward
- Describe Derivatives Used to Hedge Risk.arrow_forwarda) Define Forwards and Futures. b)Explain the differences between these instruments and how these derivatives are used to mitigate risk. nb: answer question a and barrow_forwardDescribe how the price of a futures contract is established in theory, with reference to arbitrage.arrow_forward
- Which of the following is NOT an external method of interest rate risk management? * A. Using an interest rate swap B. Using financial futures C. Using an off-balance-sheet strategy, such as a forward rate agreement D. Having fixed-interest assets financed by fixed-interest liabilities and equityarrow_forwarda)describe the major differences between futures and forwards. b)describe delivery and settlement in derivative markets. c)describe financial engineering and hybrids. d)discuss the three presuppositions for a well-functioning financial market.arrow_forwardExplain the term structure of interest rates and the relationships measured? Why is it important for all securities plotted on a given term structure to have equal default risk?arrow_forward
- Distinguish between (2) spot and futures marketsarrow_forwardIdentify the major derivative securities used to hedge against risk.arrow_forwarda)define interest rate swaptions, and differentiate between payer swaptions and receiver swaptions. b)define forward swaps. c)define risk management. d)discuss reasons for practicing risk management. e)discuss how firms can benefit from risk management.arrow_forward
- Intermediate Financial Management (MindTap Course...FinanceISBN:9781337395083Author:Eugene F. Brigham, Phillip R. DavesPublisher:Cengage Learning