Lecture Notes 3 - Corporate Finance II LECTURE 3:...

Info iconThis preview shows pages 1–10. Sign up to view the full content.

View Full Document Right Arrow Icon
Corporate Finance II LECTURE 3: INTRODUCTION: FORWARDS, FUTURES & OPTIONS
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Lecture Summary: Outline of Today’s Lecture 1The Objective 2 2Forward Contract 3 3Futures Contract 4 4Option Contract 5 5Examples 6
Background image of page 2
The Objective Recall that Price = PV [Expected future cashflows] = Magnitude and timing of cashflows → E (·) calculation. Probabilities of cashflows → E (·) calculation. Risk and timing of cashflows → PV (·) calculation. The risk of cashflows can make prices go down or up
Background image of page 3

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
The Objective How can we alter this risk? 1 Forecast future cashflows More accurate forecasts → lower risk. Forecasting can be “tricky”, it’s not clear that it always works . Forecasting gives the false impression that risk reduction is costless ! 2 Identify the risk. Identify the impact of this risk on price. Try to reduce or eliminate the risk. Try to increase the risk. Manage the Risks
Background image of page 4
The Objective We concentrate on (2), a “newer” and more informative/thoughtful approach. Makes the cost of risk reduction explicit. We can make an informed decision when evaluating the costs vs. benefits. Possible applications are limited only by: 1 Your sound understanding of the principles/basics. 2 Your imagination. 3 Your effort.
Background image of page 5

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
The Objective There are 2 ways to reduce or eliminate risk: “On balance sheet” “Off balance sheet” Some caveats: Use of derivatives may not always be “off balance sheet”.
Background image of page 6
The Objective A more accurate description might be . . . ways to reduce or eliminate risk: 1 Using transactions involving the firms real assets/operations. 2 Using transactions involving financial contracts. Over time both will tend to be used. 1 can be slower to execute, can involve longer time frames, have high transaction costs. 2 can be quicker to execute, involve short time frames, have lower transaction costs.
Background image of page 7

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
The Objective Example A domestic company faces foreign exchange risk via the presence of a foreign competitor. Assume the competitor has identical cost structures → The only risk difference is the F oreign e X change (FX ) risk. To eliminate the FX risk: 1 move the firms operations off shore (i.e. to the foreign firms country) 2 Use FX forwards, futures or options (or some combination of all four).
Background image of page 8
Definition: Forward contract A forward contract obliges the owner (contract buyer) to purchase something ( S ) at a specific date ( T ) for a specific price ( X ). The contract seller has the opposite obligation. ” is typically thought of as an asset, but can be anything. For example; interest rates, bonds, commodities, weather etc.
Background image of page 9

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Image of page 10
This is the end of the preview. Sign up to access the rest of the document.

This note was uploaded on 08/24/2010 for the course FINC 2012 taught by Professor Andrew during the Three '10 term at University of Sydney.

Page1 / 36

Lecture Notes 3 - Corporate Finance II LECTURE 3:...

This preview shows document pages 1 - 10. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online