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Chapter 23 – Enterprise Risk Management
23-1
Chapter 23
Enterprise Risk Management
CHAPTER WEB SITES
Section
Web Address
CHAPTER ORGANIZATION
23.1 Insurance
23.2 Managing Financial Risk
23.3 Hedging With Forward Contracts
23.4 Hedging With Futures Contracts
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23.5 Hedging With Swap Contracts
23.6 Hedging with Option Contracts
23.7 Summary and Conclusions
ANNOTATED CHAPTER OUTLINE
23.1 Insurance
23.2 Managing Financial Risk
Real-World Tip: The use of derivative securities is a major component of our
A. The Risk Profile
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B. A plot showing how firm value is affected by changes in prices or
rates.
C. Reducing Risk Exposure
Lecture Tip: To illustrate the concept of the risk profile, have the
students consider the concept of a reduction in risk exposure by
Now ask how they might reduce the risk of the bet, should they
become nervous about the amount of the bet prior to the game.
D. Hedging Short-Run Exposure
E. Cash Flow Hedging: A Cautionary Note
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F. Hedging Long-Term Exposure
Often called economic exposure – rooted in long-term economic
fundamentals and more difficult to hedge on a permanent basis.
Real-World Tip: Metallgesellschaft AG, the 14th largest company
G. Conclusion
23.3 Hedging with Forward Contracts
A. Forward Contracts: The Basics
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Settlement date – date when delivery occurs and the forward price
is paid
Lecture Tip: In a forward contract, both parties are legally bound
Now suppose that after the contract is signed, demand for the car
rises so that the market value of the car increases above the
B. The Payoff Profile
C. Hedging with Forwards
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23.4 Hedging with Futures Contracts
A. Trading in Futures
Lecture Tip: So, what are the major differences between an OTC
forward contract and an exchange traded futures contract?
Forward
Futures
Lecture Tip: Reconsider the Mustang example presented earlier.
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B. Futures Exchanges
C. Hedging with Futures
Lecture Tip: It may be beneficial to demonstrate a futures hedge
and the potential payoffs for a soybean farmer who anticipates a
Scenario:
Date Closing Farmer Net
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23.5 Hedging with Swap Contracts
A. Currency Swaps
Two firms agree to exchange a specific amount of one currency for
a specific amount of another currency at specific future dates.
Lecture Tip: The following example illustrates that a currency
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3. Both firms could avoid exchange rate fluctuations if they
Year
0
1
2
3
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B. Interest Rate Swaps
Just as two companies can agree to exchange currencies at specific
future dates, they can also agree to exchange the cash flows
associated with respective loan agreements.
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D. The Swap Dealer
E. Interest Rate Swaps: An Example
23.6 Hedging With Option Contracts
A. Option Terminology
B. Options versus Forwards
C. Option Payoff Profiles
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D. Option Hedging
E. Hedging Commodity Price Risk with Options
F. Hedging Exchange Rate Risk with Options
G. Hedging Interest Rate Risk with Options
H. Actual Use of Derivatives
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23.7 Summary and Conclusions
