Appendix A: Derivatives. Derivatives are financial instruments that “derive” their values from some other security or index. They serve as a form of ‘insurance” against risk. Financial futures, forward contracts, options, and interest rate swaps are the most frequently used derivatives. | Derivatives Appendix A Appendix A: Derivatives Derivatives Derivatives are financial instruments that “derive” their values from some other security or index. They serve as a form of ‘insurance” against risk. Financial Futures Forward Contracts Options Interest Rate Swaps Derivatives are financial instruments that “derive” their values from some other security or index. They serve as a form of ‘insurance” against risk. Financial futures, forward contracts, options, and interest rate swaps are the most frequently used derivatives. Derivatives Used to Hedge Hedging means taking a risk position that is opposite to an actual position that is exposed to risk. Assume a company has a large amount of outstanding debt that has a floating (variable) interest rate. If interest rates increase, this could pose a substantial cost to the company in the form of increased interest payments. The company might choose to hedge its position by entering into a transaction that would produce a gain of roughly the same amount as the potential loss if interest rates do, in fact, increase. Part I Hedging means taking a risk position that is opposite to an actual position that is exposed to risk. For instance, the volatility of interest rates creates exposure to interest-rate risk for companies that issue debt—which, of course, includes most companies. Assume a company has a large amount of outstanding debt that has a floating (variable) interest rate. If interest rates increase, this could pose a substantial cost to the company in the form of increased interest payments. Part II The company might choose to hedge its position by entering into a transaction that would produce a gain of roughly the same amount as the potential loss if interest rates do, in fact, increase. Hedging is used to deal with three areas of risk exposure: fair value risk, cash flow risk, and foreign currency risk. We will review each of these risks in the next few slides. Financial Futures A futures contract allows a . | Derivatives Appendix A Appendix A: Derivatives Derivatives Derivatives are financial instruments that “derive” their values from some other security or index. They serve as a form of ‘insurance” against risk. Financial Futures Forward Contracts Options Interest Rate Swaps Derivatives are financial instruments that “derive” their values from some other security or index. They serve as a form of ‘insurance” against risk. Financial futures, forward contracts, options, and interest rate swaps are the most frequently used derivatives. Derivatives Used to Hedge Hedging means taking a risk position that is opposite to an actual position that is exposed to risk. Assume a company has a large amount of outstanding debt that has a floating (variable) interest rate. If interest rates increase, this could pose a substantial cost to the company in the form of increased interest payments. The company might choose to hedge its position by entering into a transaction that would produce a gain of .
