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Chapter 21 -  Risk Management    2005, Pearson Prentice Hall
Innovations in Risk Management <ul><li>Futures contract : a contract to buy or sell a stated commodity or financial claim ...
Futures: a simple example <ul><li>Suppose a farmer plans to harvest 10,000 bushels of corn in six months.  The current pri...
Futures: a simple example <ul><li>If the price of corn rises to  $3.00  per bushel, the farmer gets $5,000 more for his co...
Futures Trading Requires: <ul><li>An Organized Exchange  - the Chicago Board of Trade is the oldest and largest futures ex...
<ul><li>A Futures Clearinghouse  - stands between all buyers and sellers to guarantee that all trades are honored. </li></...
Types of Futures Contracts <ul><li>Commodity Futures  - agricultural commodities (corn, wheat, orange juice, etc.) as well...
Financial Futures <ul><li>Interest Rate Futures  - used to hedge risks associated with interest rate fluctuations. </li></...
<ul><li>Foreign Exchange Futures  - used to hedge risks associated with exchange rate fluctuations. </li></ul><ul><li>A fi...
<ul><li>Stock Index Futures  - used to hedge risks associated with equity market fluctuations. </li></ul><ul><li>Investors...
Innovations in Risk Management <ul><li>Option contract : gives the owner the right to buy or sell a fixed number of shares...
Option Contracts <ul><li>Call Option : gives the owner the right to  buy  a fixed number of shares of stock at a specified...
Long Call Option Profit or Loss Stock Price $50 exercise price
Long Call Option Profit or Loss Stock Price $50 exercise price
Long Call Option Profit or Loss Stock Price $50 exercise price Profit
Long Call Option Profit or Loss Stock Price $50 exercise price Profit Loss
Short Call Option Profit or Loss Stock Price $50 exercise price
Short Call Option Profit or Loss Stock Price $50 exercise price
Short Call Option Profit or Loss Stock Price $50 exercise price Profit
Short Call Option Profit or Loss Stock Price $50 exercise price Profit Loss
Option Contracts <ul><li>Put Option : gives the owner the right to  sell  a fixed number of shares of stock at a specified...
Long Put Option Profit or Loss $50 exercise price  Stock Price
Long Put Option Profit or Loss $50 exercise price  Stock Price
Long Put Option Profit or Loss Profit $50 exercise price  Stock Price
Long Put Option Profit or Loss Profit Loss $50 exercise price  Stock Price
Short Put Option $50    Stock exercise price    Price Profit or Loss
Short Put Option $50    Stock exercise price    Price Profit or Loss
Short Put Option $50    Stock exercise price    Price Profit or Loss Profit
Short Put Option $50    Stock exercise price    Price Profit or Loss Profit Loss
Chicago Board Options Exchange <ul><li>Established in 1973 to provide exchange-listed option trading. </li></ul><ul><li>Wh...
Innovations in Options <ul><li>Option contracts can be written on: </li></ul><ul><li>Common stocks </li></ul><ul><li>Stock...
Currency Swaps <ul><li>An exchange of debt obligations in different currencies. </li></ul><ul><li>Example:  An American fi...
Other Innovations <ul><li>Long-term Equity Anticipation Securities  (LEAPS) </li></ul><ul><li>These are long-term options,...
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Fm10e ch21

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Fm10e ch21

  1. 1. Chapter 21 - Risk Management  2005, Pearson Prentice Hall
  2. 2. Innovations in Risk Management <ul><li>Futures contract : a contract to buy or sell a stated commodity or financial claim at a specified price at some specified future time. </li></ul>
  3. 3. Futures: a simple example <ul><li>Suppose a farmer plans to harvest 10,000 bushels of corn in six months. The current price is $2.50 per bushel. The farmer sells a futures contract, which will allow him to sell corn at 2.50 per bushel in six months. </li></ul><ul><li>If the price of corn falls to $2.00 per bushel, the farmer loses $5,000 ($0.50 x 10,000 bushels) on his corn, but gains $5,000 on his futures contract. </li></ul>
  4. 4. Futures: a simple example <ul><li>If the price of corn rises to $3.00 per bushel, the farmer gets $5,000 more for his corn, but loses $5,000 on the futures contract. </li></ul><ul><li>The farmer has effectively locked in a price of $2.50 per bushel and has hedged his risk. </li></ul>
  5. 5. Futures Trading Requires: <ul><li>An Organized Exchange - the Chicago Board of Trade is the oldest and largest futures exchange. </li></ul><ul><li>Standardized Contracts - for more frequent trades and greater liquidity. </li></ul>
  6. 6. <ul><li>A Futures Clearinghouse - stands between all buyers and sellers to guarantee that all trades are honored. </li></ul><ul><li>Daily Resettlement of Contracts - An initial margin of 3% to 10% of the contract’s value is paid up front. </li></ul><ul><li>A maintenance margin is required. Any end-of-day losses must be replenished by the contract holder. </li></ul>Futures Trading Requires:
  7. 7. Types of Futures Contracts <ul><li>Commodity Futures - agricultural commodities (corn, wheat, orange juice, etc.) as well as metals, wood products, and fibers. </li></ul><ul><li>Financial Futures - futures contracts on Treasury bills, notes and bonds, GNMAs, CDs, Eurodollars, foreign currencies, and stock indices. </li></ul>
  8. 8. Financial Futures <ul><li>Interest Rate Futures - used to hedge risks associated with interest rate fluctuations. </li></ul><ul><li>Example : Treasury bond futures may allow a firm to lock in an interest rate for their bond issue. </li></ul>
  9. 9. <ul><li>Foreign Exchange Futures - used to hedge risks associated with exchange rate fluctuations. </li></ul><ul><li>A firm can use a foreign exchange futures contract to lock in an exchange rate for a future transaction. </li></ul>Financial Futures
  10. 10. <ul><li>Stock Index Futures - used to hedge risks associated with equity market fluctuations. </li></ul><ul><li>Investors can buy and sell contracts based on the S&P 500 and other market indices. </li></ul>Financial Futures
  11. 11. Innovations in Risk Management <ul><li>Option contract : gives the owner the right to buy or sell a fixed number of shares of stock at a specified price over a limited time. </li></ul>
  12. 12. Option Contracts <ul><li>Call Option : gives the owner the right to buy a fixed number of shares of stock at a specified price over a limited time. </li></ul><ul><li>If you buy a call option on IBM stock, and the stock price rises enough, you can profit on the call option contract. </li></ul><ul><li>If the stock price does not rise enough, or falls, your call option contract expires worthless. </li></ul>
  13. 13. Long Call Option Profit or Loss Stock Price $50 exercise price
  14. 14. Long Call Option Profit or Loss Stock Price $50 exercise price
  15. 15. Long Call Option Profit or Loss Stock Price $50 exercise price Profit
  16. 16. Long Call Option Profit or Loss Stock Price $50 exercise price Profit Loss
  17. 17. Short Call Option Profit or Loss Stock Price $50 exercise price
  18. 18. Short Call Option Profit or Loss Stock Price $50 exercise price
  19. 19. Short Call Option Profit or Loss Stock Price $50 exercise price Profit
  20. 20. Short Call Option Profit or Loss Stock Price $50 exercise price Profit Loss
  21. 21. Option Contracts <ul><li>Put Option : gives the owner the right to sell a fixed number of shares of stock at a specified price over a limited time. </li></ul><ul><li>If you buy a put option on IBM stock, and the stock price falls enough, you can profit on the put option contract. </li></ul><ul><li>If the stock price does not fall enough, or rises, your call option contract expires worthless. </li></ul>
  22. 22. Long Put Option Profit or Loss $50 exercise price Stock Price
  23. 23. Long Put Option Profit or Loss $50 exercise price Stock Price
  24. 24. Long Put Option Profit or Loss Profit $50 exercise price Stock Price
  25. 25. Long Put Option Profit or Loss Profit Loss $50 exercise price Stock Price
  26. 26. Short Put Option $50 Stock exercise price Price Profit or Loss
  27. 27. Short Put Option $50 Stock exercise price Price Profit or Loss
  28. 28. Short Put Option $50 Stock exercise price Price Profit or Loss Profit
  29. 29. Short Put Option $50 Stock exercise price Price Profit or Loss Profit Loss
  30. 30. Chicago Board Options Exchange <ul><li>Established in 1973 to provide exchange-listed option trading. </li></ul><ul><li>Why? </li></ul><ul><li>Standardization of option contracts. </li></ul><ul><li>A regulated central marketplace. </li></ul><ul><li>An options clearinghouse corporation. </li></ul><ul><li>Certificateless trading. </li></ul><ul><li>A liquid secondary market. </li></ul>
  31. 31. Innovations in Options <ul><li>Option contracts can be written on: </li></ul><ul><li>Common stocks </li></ul><ul><li>Stock Indices </li></ul><ul><li>Interest rates </li></ul><ul><li>Foreign currency </li></ul><ul><li>Treasury bond futures </li></ul>
  32. 32. Currency Swaps <ul><li>An exchange of debt obligations in different currencies. </li></ul><ul><li>Example: An American firm and a British firm agree to pay each other’s debt obligation. </li></ul><ul><li>This allows long-term exchange rate risk hedging. </li></ul>
  33. 33. Other Innovations <ul><li>Long-term Equity Anticipation Securities (LEAPS) </li></ul><ul><li>These are long-term options, both calls and puts, which may not expire for as long as three years. </li></ul><ul><li>Can be used to hedge against longer term movements in stocks. </li></ul>

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