Hoofdstuk 1
Financial risks
o The value of the firm is influenced by unexpected changes in financial
prices
o The impact of increased financial price risks on firms: virtually every firm
considers accounting – based exposures – those exposures that would be
reflected directly in the firm’s financial statements
o Exchange rate risk:
Exchange rate exposure
Exchange rate volatility
Derivative: an instrument whose value depends on the values of other more
basic underlying variables. A derivative can be constructed on anything that has
a price. Examples:
o Futures contracts;
o Forward contracts;
o Swaps;
o Options.
Ways derivatives are used
o To hedge risks
o To speculate (take a view on the future direction of the market)
o To lock in arbitrage profit
o To change the nature of a liability
o To change the nature of an investment without incurring the costs of
selling one portfolio and buying another
Exchange rate risk
1) Transaction exposure: a transaction exposure exists when a change in
one of the financial prices (exchange rates) will change the amount of a
receipt or an expense
The risk is created at the moment that contracts (to import or export
goods) are signed
Example: Heineken
2) Translation exposure: a translation exposure reflects the change in the
value of the firm as foreign assets are converted to the home currency
Think about the example of Ahold was having a lot of subsidiaries in the
US.
3) Economic exposure (or competitive exposure): changes in foreign
exchange rates will change the firm’s receipts or expenditures not only
because of the direct price change but also because the price change will
change the amount that the firm sells or buys.
The competitiveness of European firms will be influenced by a real
appreciation of the euro
Example: structure of costa and revenues of firm K and its competitor firm
L.
Question 1 B; GBP and dollar,
Question 2 A; GBP, Dollar and Swiss Franc.
Overview of the risk management process
1) Confronted with the increased volatility in finical prices, companies found
that the first and most obvious approach was to try to forecast future
prices more accurately… however economist were generally unsuccessful
, in predicating changes in exchange rates, interest rates and commodity
prices
2) Alternative: Risk management:
On balance sheet (inflexible) methods
Moving production abroad
Borrowing in the competitor’s currency
Off balance sheet instruments
Forwards and futures
Swaps
Options
Forward contract/future contract: obligates its owner to buy a given asset on
a specified date at a price (exercise price/forward price) specified at the
origination of the contract.
The trader who agreed to buy has a long-term futures position and the trader
who agreed to sell has a short-term futures position.
Future price: prices for a particular contract is the price at which you agree to
buy or sell. It is determined by supply and demand in the same way as a spot
price.
Spot contract: there is an agreement to buy or sell the asset immediately (or
within a very short period of time.
There is a little difference between forward and future contracts. Forward
contracts trade in the over-the counter markets and future contracts are traded
on exchanges.
Examples:
o buy 100 oz. of gold @ US$1050/oz. in
December
o sell £62,500 @ 1.5500 US$/£ in
March
o sell 1,000 bbl. of oil @ US$75/bbl. in April
Risk management oce possibility 1 and 2
Exchange rate risk (transaction exposure)
Example 2: a Dutch company (Oce) signs a contract to sell 10 machines to a
company in the USA for $10,000 / machine.
Spot rate: S0 = $1.125 / €1
Forward rate: F0 = $1.125 / €1 (in six month)
1) If Oce specifies the price in euros, the exchange rate risk is shifted to the
US-firm
2) If Oce uses the forward market: Oce is sure it will receive: $10,000 * 10 /
($1.126 / € 1) = €88,810
Buy put options to sell $100.000 for €0.89/$
And Pay Premium (Not specified)
A. over 6 months S = $1.15/ € (approx. €0.87 / $)
=> use your put options
B. over 6 months S = $1.10/ € (approx. €0.91 / $)
=> Don’t use your put options
Option contracts: a right and not an obligation to buy or sell an asset
Call option: right to buy an asset by a certain date for a certain price
European options: only on expiration date
American options: before or on expiration date
, Stock price value call option
on expiration date on expiration date
Higher than exercise price Stock price – exercise price
Smaller than exercise price 0!
o Example 1: 21 January 2021: stock price Randstad = € 55.50
Call option 19 February (Third Friday in February)
Exercise price € 56, Price call option (Premium) = € 1.50
o If on 19 February, Price Randstad = € 60
Value of the call option: € 4.00 (Profit: € 4.00 - € 1.50 = € 2.50)
o If on 19 February, Price Randstad = € 51
Value of the call option: € 0! (Loss: € 1.50)
Call options
o Net profit from purchasing a contract of 100 Randstad call options with a
strike price of euro 56 (a)
o Net profit from selling a contract of 100 Randstad call options with a strike
price. Of euro 56 (b)
(Premium euro 1.50)
Put option: right to sell an asset by certain date for a certain price.
Stock price value put option
on expiration date on expiration date
Higher than exercise price 0!
Smaller than exercise price Exercise price – stock price
o Example 1: 21 January 2021: stock price Randstad = € 55.50
Put option 21 February (third Friday in February)
o Exercise price € 56, Price put option = € 2.00
o If on 19 February, Price Randstad = € 60
Value of the put option: € 0 (Loss € 2.00)
o If on 19 February, Price Randstad = € 51
Value of the put option: € 5.00 (Profit: € 5.00- € 2.00 = € 3.00)
S (Randstad) = 55.50 (x = 56)
Premium put = 2.00 > premium call 1.50 the put option is ‘in the money’, if
you use that today, it has still some value.
Which type of traders use financial instruments?
o Hedgers: firms. Hedge against unexpected price risks (block 4). Hedge
are not subject to the same rules as mutual funds and cannot offer their
securities publicly.
Mutual funds must:
Disclose investment policies;
Makes shares redeemable at any
time;
Limit use of leverage;
Take no short positions.
Financial risks
o The value of the firm is influenced by unexpected changes in financial
prices
o The impact of increased financial price risks on firms: virtually every firm
considers accounting – based exposures – those exposures that would be
reflected directly in the firm’s financial statements
o Exchange rate risk:
Exchange rate exposure
Exchange rate volatility
Derivative: an instrument whose value depends on the values of other more
basic underlying variables. A derivative can be constructed on anything that has
a price. Examples:
o Futures contracts;
o Forward contracts;
o Swaps;
o Options.
Ways derivatives are used
o To hedge risks
o To speculate (take a view on the future direction of the market)
o To lock in arbitrage profit
o To change the nature of a liability
o To change the nature of an investment without incurring the costs of
selling one portfolio and buying another
Exchange rate risk
1) Transaction exposure: a transaction exposure exists when a change in
one of the financial prices (exchange rates) will change the amount of a
receipt or an expense
The risk is created at the moment that contracts (to import or export
goods) are signed
Example: Heineken
2) Translation exposure: a translation exposure reflects the change in the
value of the firm as foreign assets are converted to the home currency
Think about the example of Ahold was having a lot of subsidiaries in the
US.
3) Economic exposure (or competitive exposure): changes in foreign
exchange rates will change the firm’s receipts or expenditures not only
because of the direct price change but also because the price change will
change the amount that the firm sells or buys.
The competitiveness of European firms will be influenced by a real
appreciation of the euro
Example: structure of costa and revenues of firm K and its competitor firm
L.
Question 1 B; GBP and dollar,
Question 2 A; GBP, Dollar and Swiss Franc.
Overview of the risk management process
1) Confronted with the increased volatility in finical prices, companies found
that the first and most obvious approach was to try to forecast future
prices more accurately… however economist were generally unsuccessful
, in predicating changes in exchange rates, interest rates and commodity
prices
2) Alternative: Risk management:
On balance sheet (inflexible) methods
Moving production abroad
Borrowing in the competitor’s currency
Off balance sheet instruments
Forwards and futures
Swaps
Options
Forward contract/future contract: obligates its owner to buy a given asset on
a specified date at a price (exercise price/forward price) specified at the
origination of the contract.
The trader who agreed to buy has a long-term futures position and the trader
who agreed to sell has a short-term futures position.
Future price: prices for a particular contract is the price at which you agree to
buy or sell. It is determined by supply and demand in the same way as a spot
price.
Spot contract: there is an agreement to buy or sell the asset immediately (or
within a very short period of time.
There is a little difference between forward and future contracts. Forward
contracts trade in the over-the counter markets and future contracts are traded
on exchanges.
Examples:
o buy 100 oz. of gold @ US$1050/oz. in
December
o sell £62,500 @ 1.5500 US$/£ in
March
o sell 1,000 bbl. of oil @ US$75/bbl. in April
Risk management oce possibility 1 and 2
Exchange rate risk (transaction exposure)
Example 2: a Dutch company (Oce) signs a contract to sell 10 machines to a
company in the USA for $10,000 / machine.
Spot rate: S0 = $1.125 / €1
Forward rate: F0 = $1.125 / €1 (in six month)
1) If Oce specifies the price in euros, the exchange rate risk is shifted to the
US-firm
2) If Oce uses the forward market: Oce is sure it will receive: $10,000 * 10 /
($1.126 / € 1) = €88,810
Buy put options to sell $100.000 for €0.89/$
And Pay Premium (Not specified)
A. over 6 months S = $1.15/ € (approx. €0.87 / $)
=> use your put options
B. over 6 months S = $1.10/ € (approx. €0.91 / $)
=> Don’t use your put options
Option contracts: a right and not an obligation to buy or sell an asset
Call option: right to buy an asset by a certain date for a certain price
European options: only on expiration date
American options: before or on expiration date
, Stock price value call option
on expiration date on expiration date
Higher than exercise price Stock price – exercise price
Smaller than exercise price 0!
o Example 1: 21 January 2021: stock price Randstad = € 55.50
Call option 19 February (Third Friday in February)
Exercise price € 56, Price call option (Premium) = € 1.50
o If on 19 February, Price Randstad = € 60
Value of the call option: € 4.00 (Profit: € 4.00 - € 1.50 = € 2.50)
o If on 19 February, Price Randstad = € 51
Value of the call option: € 0! (Loss: € 1.50)
Call options
o Net profit from purchasing a contract of 100 Randstad call options with a
strike price of euro 56 (a)
o Net profit from selling a contract of 100 Randstad call options with a strike
price. Of euro 56 (b)
(Premium euro 1.50)
Put option: right to sell an asset by certain date for a certain price.
Stock price value put option
on expiration date on expiration date
Higher than exercise price 0!
Smaller than exercise price Exercise price – stock price
o Example 1: 21 January 2021: stock price Randstad = € 55.50
Put option 21 February (third Friday in February)
o Exercise price € 56, Price put option = € 2.00
o If on 19 February, Price Randstad = € 60
Value of the put option: € 0 (Loss € 2.00)
o If on 19 February, Price Randstad = € 51
Value of the put option: € 5.00 (Profit: € 5.00- € 2.00 = € 3.00)
S (Randstad) = 55.50 (x = 56)
Premium put = 2.00 > premium call 1.50 the put option is ‘in the money’, if
you use that today, it has still some value.
Which type of traders use financial instruments?
o Hedgers: firms. Hedge against unexpected price risks (block 4). Hedge
are not subject to the same rules as mutual funds and cannot offer their
securities publicly.
Mutual funds must:
Disclose investment policies;
Makes shares redeemable at any
time;
Limit use of leverage;
Take no short positions.
