Hedging Risk Exposure:

Disadvantage: 

In theory:

1. assume no tax and has same transaction cost, then the value dos not change…..Too fake
2.  CPAM suggests focusing on  systematic risk (common for player) while non-systematic ones can be diversified (no perfect market)
3. Derivative fully reflect underlying. Of course no, partial correlation, even no related derivative available

They do not consider bankruptcy.

In practice:

1.  lose focus on making money
2. Lack of knowledge
3. Reduce volatility of value may result in reduce of earning cash flow

Advantage:

1. Stable earning make fund raising easy
2. Achieve board of director's goal
3. Stable operation cost (put on consuming materials)
4. Chance to get low tax

Hedging  Decision

 

Hedging  Decisions

The role of board of director

Decide firm's risk appetite with

1. Decision on appetite  (accounting or economic, eg. Fx, short or long term heding eg. Put maturity, hard limit on quantities )
2. With Quantative
3. And qualitive method

Map risks

Analyze top 10 risk exposures according to market risk, credit risk, operation, business and so on. Give it dollar value. Ready for next step, hedge

Hedging risks

Pricing risk: fwd or call

FX: FX fwd, swap

Interest rate:  irs

Static vs Dynamic

Static, once decided, does not change

Dynamic, changing  but more transaction cost

Others:

1. Time horizon goad matches
2. If hedging position matches the goad
3. Tax

Hedging instrument

OTC: difficult to price, less info, credit risk and so on…but I think it is cheaper most of time and designed for purchaser.

Exchange Traded : standard, clear price, enough info