Financial Risks and Hedging Strategies
Translated by
ScribdTranslationsFinancial Risks and Hedging Strategies
Translated by
ScribdTranslationsFinancial Risks and
Hedging instruments
Réalisé par: Assa TRAORE
Mohamed BAGHDADI
Fadoumo SAID DJAMA
SUMMARY
Introduction
Section 1: Financial Risks and Exchange Market
I. Financial risks
II. The exchange markets
Section 2: Hedging Instruments
I. The risk hedging instruments
financiers
Conclusion
Section 2: Instruments of
cover
I. Hedging Instruments: Products
derivatives
A derivative product is:
• a contract between a seller and a buyer
• whose value derives from the price of underlying assets
adjacent.
It allows to cover the risks related to these
assets.
For each risk, there are
hedging instruments.
Financial risks Proposed hedging instruments
Interest rate risk Forward rate agreement (FRA) - Term FRA - interest rate swap
interest - futures - interest rate options (collar, floor,
cap)
Currency risk Currency swaps - foreign exchange options - currency warrants -
currency futures.
Risk of fluctuation in raw material prices Forward contract - swap - options - forward
Risk of share prices and indices Index futures - index options - index warrants -
stock options - stock index
1. Risk hedging instruments
of interest rate
a. Forward Rate Agreement (FRA)
It is a contract that allows you to set today the
interest rate of a loan or an investment
future for a date, an amount, and a duration
determined.
Differential = amount x (market rate –
guaranteed rate)x guarantee period/360
Example: a company needs to borrow 1,000,000 dirhams
in 3 months for a duration of 6 months. Anticipating a
rate increase in 3 months, she wants to fix today
March 15, the interest rate of his future loan.
She buys a 6-month FRA in 3 months from her bank.
following conditions:
• Contract conclusion date: March 15
• Montant : 1.000.000 dhs
• Guaranteed rate: 3.5%
• Warranty period: from June 15 to December 15, totaling 183 days
• Due date: December 15
• Start date of the operation: June 15
• As of June 15, the market interest rate was
3.75 %.
Let's calculate the interest differential:
It is the bank that must pay the company the
interest differential because the guaranteed rate of the FRA
is lower than the market rate (the expectations
the company's are good).
So differential = 1,000,000 x (3.75% - 3.50%) x
183 / 360 = 1270.83 dirhams.
b. Forward Rate Agreement
The forward contract allows to set
immediately the interest rate of a loan
or a loan that will be made later.
Unlike the FRA, it involves conducting two
simultaneous borrowing and lending operations at
different deadlines, to protect oneself against the
interest rate risk.
Example: a company plans to carry out a
loan of 5,000,000 dirhams in 3 months for
a duration of 6 months. To protect oneself against the
interest rate risk, it enters into a FRA at
terms with its bank. To do so, it will
to borrow for a period of 9 months and
to place the requested amount on the same day for
a duration of 3 months.
Today loan for 9 months
Placement for 3 months 6 months
The forward assures the company of
to have a loan in 3 months
for 6 months, at a guaranteed rate.
c. Interest rate swap
This is a contract that allows for
two parties to exchange on date
fixed interest flows of capital
calculated based on rate references
different. Only the differential
interest is paid and the capital is not
never paid.
Example: a company took out a loan of
5,000,000 € over five years at a fixed rate of 9%
repayable at maturity. The treasurer anticipates a
drop in rates, he concludes a swap with a bank
following in order to benefit from debt at a rate
variable and take advantage of the decrease in rates.
The characteristics of the swap are as follows:
• Durée du contrat : 5ans
• The bank pays a fixed rate of 7.5%
• The company pays a variable rate: TAM+1.25%
The risk for this company would be not to
to benefit from a reduction in its charges
financial.
Before the signing of the swap
The company The bank
fixed rate of 9%
After the signing of the swap
fixed rate of 9%
The company The bank
receives a fixed rate of 7.5%
variable rate verse TAM+1;25%
Calculation of payments made at the end of
every year
• New debt ratio: 9% - 7.5%
(TAM + 1.25%) = - TAM - 2.75%
This gives us rate = TAM + 2.75%
End of year 1 End of Year 2 End of year 3
TAM Hypothesis 6% 7% 6.5%
Fixed rate 9% 9% 9%
Variable rate TAM + 2.75 = 8.75% TAM + 2.75 = 9.75% TAM + 2.75 = 9.25%
Versement (9% - 8.75%) x 5000000 = (9% - 9.75%) x 5000000 = - (9% - 9.25%) x 5000000 = -
12,500 37.500 12.500
Difference in interest received Difference in interest paid Difference in interest paid
• Forward contract or futures