The participants in the derivatives markets are generally classified as hedgers and speculators. The hedgers use derivatives as main purpose to protect against adverse changes while speculators enter a derivative contract with attempt to profit from anticipated changes in market prices. One of the biggest questions in regard to the treatment of derivatives tools is whether actually they are used for hedging or speculation. (Adam and Fernando 2006)
According to Guay (1999) firms can reduce dramatically their risk by the means of derivatives. But in the same research he finds out that derivatives could be used either do increase or decrease risk. Guay (1999) undertakes an empirical examination of new derivative users in attempt to find out whether derivatives are used to reduce firm’s risk. The results show that firms use derivatives to hedge, not to speculate by increasing company’s risk. The investigation is conducted for a sample of 254 non-financial corporations starting using derivatives and the outcomes indicate that during this period the companies’ risk has declined with about...
Today, many health care organizations have been forced to reduce their workforce due to the downturn of the economy. Marshall and Broas (2009) state that whenever health care organizations conduct a reduction in force (RIF); there is the potential for legal risk. However, with proper planning and implementing, employers can minimize the risk of litigation (Marshall & Broas, 2009; Segal, 2001). Hence, before carrying out a 10% reduction in workforce, there are a number of steps that need to be taken to ensure it is successful.
Derivatives as defined by Warren Buffet are time bombs, both for the companies that make use of them and the monetary framework. Fundamentally these instruments call for cash to change hands at a future date, with the add up to be dictated by one or more reference things, for example, premium rates, stock costs, or money values. Case in point, in the event that you are either long or short a S&P 500 prospects contract, you are a gathering to an extremely straightforward derivatives transaction, with your addition or misfortune determined from developments in the list. Derivatives contracts are of shifting length of time, running now and again to 20 or more years, and their quality is regularly attached to a few Variables.
The hedging strategy that I have chosen is that of Southwest Airlines strategy over the past decade. Up until the 3th quarter of 2008 they enjoyed 69 straight quarterly profits dating back to 1991. In 2008 Southwest had over 70% of its fuel needs hedged at around $51 a barrel. Using an...
Value-at-Risk is becoming extremely popular and is being bandied by pundits into measuring other risks such as credit and operational risk, and many believe that all risks of a company should be computed with a single risk measure. The author believes that if this were so there would be a lot of backlash due to VaR being controversial and that it still may be ineffective for analyzing these other risks as well as market risk.
Throughout financial markets worldwide the use of derivatives as a risk management methods have increased substantially over the last few decades. Derivatives are considered a financial instrument that derive their value from another financial asset or variable and as such they contrast from more commonly known financial instruments such as stocks and bonds. The main goal of derivatives is to protect investors against risk by allowing them to hedge their risk in the future value of an underlying asset (Derivative, 2016). This can be accomplished through different derivative forms, including swaps, options, forwards and futures. Forwards and futures are legally binding agreements used by investors
hedging risks and what instruments to use are really depend on whether the company is risk
Most people know that an option is a choice. It is a choice to buy that new compact disc, a choice to upgrade to leather on a new car, or a choice to speculate in the market. Options are a way to reduce risk associated with trading stocks and are quite advantageous in a capitalist society. An option is a “contract between two parties to purchase or sell a commodity futures contract at a predetermined price within a specific time period. Every option transaction has an option buyer and an option seller (4, p. 236).” The advent of organized options trading by the Chicago Board Options Exchange created a new way to play the market. Options can be used to hedge risk and to take profits larger than would be possible by buying and selling stock. This result can be accomplished using a variety of combinations to be discussed later in this paper. These strategies can be useful as pertaining to the options trader who wants to make the most profit with the least amount of risk. Elementary pricing of options will help the reader in understanding some of the differences in premiums and why the differences are so large. The Chicago Board Options Exchange has changed the way that options are traded through advances in technology to the point that options are bought and sold instantaneously with almost a 100% guarantee of credibility. This is one of the main reasons for the options explosion.
Thermodynamics is the branch of science concerned with the nature of heat and its conversion to any form of energy. In thermodynamics, both the thermodynamic system and its environment are considered. A thermodynamic system, in general, is defined by its volume, pressure, temperature, and chemical make-up. In general, the environment will contain heat sources with unlimited heat capacity allowing it to give and receive heat without changing its temperature. Whenever the conditions change, the thermodynamic system will respond by changing its state; the temperature, volume, pressure, or chemical make-up will adjust accordingly in order to reach its original state of equilibrium. There are three laws of thermodynamics in which the changing system can follow in order to return to equilibrium.
Many years ago humans discovered that with the use of mathematical calculations many things can be calculated in the world and even the universe. Mathematics consists of many different operations. The most important that is used by mathematicians, scientists and engineers is the derivative. Derivatives can help make calculations of anything with respect to another event or thing. Derivatives are mostly common when used with respect to time. This is a very important tool in this revolutionary world. With derivatives we can calculate the rate of change of anything with respect to time. This way we can have a sort of knowledge of upcoming events, and the different behaviors events can present. For example the population growth can be estimated applying derivatives. Not only population growth, but for example when dealing with plagues there can be certain control. An other example can be with diseases, taking all this events together a conclusion can be made.
One of the advantages of financial derivatives is there is numerous people keeping track of the price fluctuations and the trade. Another advantage is “derivative instruments do not involve risk…. they redistribute risk between various market participants” (Finance and Money). Another advantage is the amount of participants lowers the transaction costs. There is also disadvantages to the derivative financial instruments. The disadvantages consist of raised volatility, high amount of bankruptcies, and the constant need for regulations.
However, owing to the complexity and non-accessibility of the law, very few derivative actions succeeded. Among the reasons as experienced in many jurisdictions would tell us that the costs of the litigations, proceedings and attorneys’ fees relative to this claim can be an alarming obstacle for shareholders suing on behalf of the company. These factors, together with the difficulty of establishing liability and seeking permission to proceed with the c...
In addition, derivative securities are also helpful to enhance a portfolios performance. This highlights the need for an investor to understand the options before they begin to compose their portfolio. International Portfolio Diversification A diverse portfolio is essential for an investor to expose their portfolio to the necessary risk due to the differences in characteristics from one asset to the next; these assets will be within both the domestic and international market. Fisher (2012) states that a “global portfolio should earn a higher return for the same level of risk and take less risk for the same level of return.” Therefore, an investor can achieve a reduction in risk through international diversification.
The importance of the topic is including a reduction in the risk and losses. Hedging effectiveness improved portfolio risk/return. Hedging is one of the main functions provided by future market and also the reason for existence of future markets. The main purpose and benefit of hedging on the futures markets is to minimize possible revenue losses associated with the adverse cash price changes. The risk of price variability of an asset can be managed by mechanism of
Long term securities are similar to short term securities, where a firm may invest in human resources, bonds, stocks, real estate, equipment, cash, etc… The advantage of long term investments is that they allow a firm to gain a steady income over a longer period of time than short term investments. Some people may question why a firm may invest in human resources, not realizing that having a staff of workers helps reduce cost. Although this an indirect cost to an entity, but it can be beneficial, because of the continuity of operations. An entity can save on the training of new personnel and supplies will continue to meet demand of the products or services provided by the firm. The main difference between short term securities and long term securities is that, short term securities are sold in a short period, whereas long term securities may never be sold (Schroeder et al, 2011). Firms may invest in long term securities, with the impression that the security will mature in ten to fifteen years. Some companies invest millions of dollars in long term securities risking the possibility of gaining a profit; however, over time there are so many changes in the economy, governmental regulations and policies and even the change in competition can prove challenging during a length of time. Therefore, managers should strategically make decisions on the type of long term investments that would benefit their firms and shareholders. Investors are particularly interested in forecasting a firm’s future cash flow and associated risks (Arora et al, 2014).
In modern times, derivative products have become widely used tools to help investors, organizations and governments manage risk that could arise from factors like unstable commodity prices, changes in currency rates and interest rates in general. A derivative is an asset whose value is derived from the value of an underlying asset that is used to hedge a potentially risky outcome. These underlying assets include a wide range of effects, such as metals, commodities, energy sources and financial assets. Derivatives are evaluated on a balance sheet differently depending their type. This is due to the way they are bought, sold and traded. As such, derivatives come in different variants with the most common being Forwards and Futures Contracts, Call and Put Options and Swaps. This paper will evaluate the potential gains and losses for the different derivative variants while describing their risk potential. As well, this paper will discuss different methods for valuing derivatives.