Research Project

Assume that your team has recently been appointed as the “Financial Risk Management” team of your organisation. For this purpose, select a company of your choice (companies will be allocated to each group in the first class) and assess how well the company manages its risk by addressing the following issues. Your team has been requested to prepare a report to present to the board.

(a) Identify the primary financial risks that your company is exposed to. For this purpose asset and liability structures need to be considered. In this section you MUST discuss the outlook for the each variable and the related risk exposure.

(b) Make firm recommendations on whether to hedge all, part or none of the financial risk exposures that you identified in part (a) above. You MUST provide some explanation for each of your recommendations. You need to explain whether your hedging strategy is in accordance with the current strategy of the company and the reasons for suggesting this strategy. (You are not required to specify the type of derivative to be used to hedge in response to this question).

(c) To make recommendations on which derivative instruments (for example, options, futures etc.) to use to implement any hedges that you have recommended in part (b) above. Once again, you MUST explain your recommendations. This means that you will need to provide very well researched and fully explained reasons for your responses to part (b). However, it is advised that you make at least some hedge recommendations to make responses to parts (c) and (d) more meaningful]. You are NOT required to propose details of how to implement your hedge recommendations in this part – this is to be done in part (d).

(d) To propose, in accordance with each of your recommendations in (c) above, specific hedging strategies which require you to describe the following:

i. the exposures to be hedged,

ii. what percentage proportion of the exposure is to be hedged,

iii. which derivative(s) are to be used to hedge each exposure,

iv. the number of derivative contracts for each hedge,

v. the delivery months (or duration of swaps) for each derivative, and

vi. the prices at the time of making the recommendation - futures prices, option strike prices (including an explanation of the choice of strike price(s)] and the interest rate for currency swaps (you will need to research this- use actual data).

For part (d) you may assume that the hedge horizon is mid-December and that you can use futures and options with a December expiration date for hedging.

Also, in part (d) if you recommend option strategies you may also wish to consider strategies that require the ‘purchase and sale’ of two different options (e.g. an option spread) to reduce the cost of the option strategy.

In this section you MUST show all calculations and include your responses in a table format.

(e) Is the company adequately hedged? Why or why not? What are your recommendations?