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5 sl - THE UNIVERSITY OF HONG KONG FACULTY OF BUSINESS AND...

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1 T HE U NIVERSITY OF H ONG K ONG F ACULTY OF B USINESS AND E CONOMICS FINA0301 CDE - D ERIVATIVES First Semester, 2009-2010 Tutorial 3 Slide Chapter 4 – Introduction to Risk Management checkbld Basic Risk Management What is Risk Management? A firm that actively uses derivatives and other techniques to alter its risk and protect its profitability is engaging in risk management. Producer’s Perspective square4 Short Forward A gold mining firm (a Long position in gold) enters into a short forward contract, agreeing to sell gold at a price of $420/oz in a year. Fixed Cost: $330 Variable Cost: $50
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FINA0301 – Tutorial 3 Slide Mr. Clive Man Chung HO 2 Gold price in 1 year Fixed Cost Variable Cost Unhedged Net Income Profit on Short Forward ( F-S T ) Net Income on Hedged Position $350 -330 -$50 -$30 $70 $40 $400 -330 -$50 $20 $20 $40 $450 -330 -$50 $70 -$30 $40 $500 -330 -$50 $120 -$80 $40
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FINA0301 – Tutorial 3 Slide Mr. Clive Man Chung HO 3 square4 Long Put Option Buying a put option allows a producer to have higher profits at high output prices, while providing a floor on the price. A gold mining firm purchases a 420-strike put, at a premium of $8.77/oz. Fixed Cost: $330 Variable Cost: $50 Effective Interest Rate: 5% Future Value of the option Premium: $8.77 × 1.05 = $9.21 K = $420 Gold price in 1 year Fixed Cost Variable Cost Unhedged Net Income Profit on Put Option Net Income on Hedged Position $350 -330 -$50 -$30 $60.79 $30.79 $400 -330 -$50 $20 $10.79 $30.79 $450 -330 -$50 $70 -$9.21 $60.79 $500 -330 -$50 $120 -$9.21 $110.79
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FINA0301 – Tutorial 3 Slide Mr. Clive Man Chung HO 4 square4 Written Call A written call reduces losses through a premium, but limits possible profits by providing
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