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Derivatives for 432

Derivatives for 432 - Click to edit Master subtitle style...

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Unformatted text preview: Click to edit Master subtitle style 4/22/11 Derivatives A Basic Overview International Corporate Finance Class Ned Hill 4/22/11 2 Examples of Risks F aced by 1. A US corporation sells software into the Asian market 1. A large pension fund buys shares every month based on the subscriptions they receive 2. A company has borrowed money for 5 years where the interest they pay changes every three months 3. An Australian mining company sells its production overseas 4. GM faces exposure to the Yen because of 4/22/11 How derivatives might be used by a CFO Definition of derivative Options Forwards Futures Swaps Overview 4/22/11 What is a Derivative? A derivative is a risk-shifting agreement, the value of which is derived from the value of an underlying asset (or multiple assets, or even underlying events like the weather) The underlying asset could be a physical commodity, an interest rate, a company’s stock, a stock index, a currency, or virtually any other tradable instrument upon which two parties can agree Three basic types of derivatives ◦ Options: “ I may ” ◦ Futures or Forwards: “ I will ” 4/22/11 How CFOs Use Derivatives Derivatives can be used to transfer or remove a risk exposure  Hedging  Manage risk—limit potential losses Derivatives can be used to enhance a return  Speculating  Express a particular belief about the direction of the market  Arbitrage  Finding mispriced instruments, increase profitability 4/22/11 6 Defining Characteristics Fixing the Value of a Future Cash Flow An option fixes the price of an asset today for delivery on a single future date but with the ability of the contract buyer to walk away ◦ A fee is payable A forward / futures contract fixes the price of an asset today for delivery on a single future date ◦ Can’t walk away ◦ No fees are payable A swap contract fixes the price of an asset today for multiple delivery dates in the future ◦ Can’t walk away ◦ No fees are payable 4/22/11 Price of XYZ 40 45 50 55 60 65 70 75 80 85 90 95 100 105 110 115 120 Profit 20 15 10 5-5-10-15-20 Loss Current Price Could lose a lot of money in this range Could make a lot of money in this range “Long Position” Profit Graph 4/22/11 Price of XYZ 40 45 50 55 60 65 70 75 80 85 90 95 100 105 110 115 120 Profit 20 15 10 5-5-10-15-20 Loss Strike Price Call Price----Don’t exercise...
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