Risk Management and Financial Instruments: Terms and Definitions, Quizzes of Corporate Finance

Download Risk Management and Financial Instruments: Terms and Definitions and more Quizzes Corporate Finance in PDF only on Docsity! TERM 1 Risk DEFINITION 1 -Variance of possible outcomes; the greater is the variance of possible outcomes, the greater the risk. -Common types of risk exposure: Hazards, Interest Rate, Exchange Rate, Commodity Price TERM 2 Risk Management DEFINITION 2 -"Smoothing" the variability of cash flows by transferring the risk to another party. -Efficiently allocating risk from parties that are more risk averse to parties that are less risk averse. TERM 3 Insurance DEFINITION 3 -Exchanging a random future loss for a certain, up-front expense. -Some companies legally must carry insurance. - Firms may have trouble raising necessary capital. -Cost of capital is lower because bankruptcy cost and probability in event of loss are reduced. TERM 4 Hedging DEFINITION 4 -Reducing a firm's exposure to price, interest rate, or exchange rate fluctuations. -Firms can work to reduce risk which investors cannot diversify away such as financial distress costs, issuance costs, etc. -Unhedged firms make sub-optimal investment decisions. -Many companies have a natural hedge in place. - Managers can use options to create cash flows that meet their own personal demand for funds TERM 5 Speculating DEFINITION 5 -Making a bet about price, interest rate, or exchange rate changes without having an underlying exposure to be offset. TERM 6 Process of Risk Management DEFINITION 6 -Measure the firm's risk exposure to interest rates, exchange rates, and commodity prices. -Identify financial tools that are available for managing (reducing) these risk exposures. - Decide how to employ available financial tools to reduce exposure. TERM 7 Risk Profile DEFINITION 7 -A graph of changes in the value of the firm as a function of unexpected changes in the chosen risk variable. -Sensitivity Analysis: Estimate the sensitivity of income flows as part of the planning and budgeting process. -Regression Analysis: Regress historical equity market values against levels of interest rates, exchange rates, or commodity prices to get "betas" for these variables TERM 8 Duration DEFINITION 8 -The duration of the firm's equity tells us the expected decrease in the value of the equity in response to a 1% increase in the interest rate. TERM 9 On-Balance Sheet Methods to Control Risk Exposures DEFINITION 9 -Change maturity structure of assets or liabilities. -Hedge with vertical integration. -Store large inventories of volatile- cost inputs. -Enter into long-term supply contracts to lock input prices. -Borrow in a foreign currency or at a floating rate. -Move a production facility abroad to match production and sales currencies. TERM 10 Foward or Futures Contracts DEFINITION 10 -Obligates its owner to BUY a specified asset on a specified date at a price specified at the origination of the contract. -The buyer benefits from unexpected increases in the price of the asset. - Choose a position that is the mirror image of your firm's risk profile. If the value of your firm is negatively related to unexpected increases in the price of an input, you would buy a forward or futures contract on the input.