Corporations must cope with fluctuations in interest rates, commodity prices, and exchange rates. This chapter discusses how they do it, with particular attention paid to financial instruments such as futures contracts, options, and swap agreements. | Chapter Outline Chapter 24 Risk Management: An Introduction to Financial Engineering Chapter Organization Hedging and Price Volatility Managing Financial Risk Hedging with Forward Contracts Hedging with Futures Contracts Hedging with Swap Contracts Hedging with Option Contracts Summary and Conclusions CLICK MOUSE OR HIT SPACEBAR TO ADVANCE Irwin/McGraw-Hill copyright © 2002 McGraw-Hill Ryerson, Ltd. Example: Statement of Risk Management Policy at Walt Disney Company “The company’s foreign currency revenues continue to grow and thus, Disney’s management believes it is prudent to reduce the risk associated with fluctuations in the value of the US dollar in the foreign exchange markets. The Company uses foreign currency forward and option contracts to reduce the impact of changes in the value of its existing foreign currency assets and liabilities, commitments and anticipated foreign currency revenues denominated in Japanese yen, French francs, German marks, British pounds, and other currencies. The primary focus of the company’s foreign exchange risk management program is to reduce earnings volatility. By policy, the company maintains hedge coverages between minimum and maximum percentages of its anticipated foreign exchange exposures for each of the next five years.” (Emphasis added) Excerpt from the Walt Disney Company 1995 Annual Report 1997-1999 Currency crises In 1997, the currencies of a number of developing countries faced dramatic devaluation, with arbitrageurs attacking first the currencies of Indonesia and Thailand, then South Korea, Russia and Brazil. The collapse of the Russian ruble played an important role in the demise of Long-Term Capital Management (LTCM). Nortel Networks stock price (logarithmic scale) In 1997, the currencies of a number of developing countries faced dramatic devaluation, with arbitrageurs attacking first the currencies of Indonesia and Thailand, then South Korea, Russia and | Chapter Outline Chapter 24 Risk Management: An Introduction to Financial Engineering Chapter Organization Hedging and Price Volatility Managing Financial Risk Hedging with Forward Contracts Hedging with Futures Contracts Hedging with Swap Contracts Hedging with Option Contracts Summary and Conclusions CLICK MOUSE OR HIT SPACEBAR TO ADVANCE Irwin/McGraw-Hill copyright © 2002 McGraw-Hill Ryerson, Ltd. Example: Statement of Risk Management Policy at Walt Disney Company “The company’s foreign currency revenues continue to grow and thus, Disney’s management believes it is prudent to reduce the risk associated with fluctuations in the value of the US dollar in the foreign exchange markets. The Company uses foreign currency forward and option contracts to reduce the impact of changes in the value of its existing foreign currency assets and liabilities, commitments and anticipated foreign currency revenues denominated in Japanese yen, French .
