Corporate Financial Risk Management - Essay Example

Therefore, it is recommendable for the firm to hedge against price volatility by buying futures contract. Table of contents Introduction……………………………………………………………………………… 4 Designing of the hedging strategy…………………………………………………………4 An assessment of the impact of the above hedging strategy………………………………5 Advantages and disadvantages of futures contract ……………………………………….

6 Misuse of financial derivates………………………………………………………………7 Conclusion and recommendations……………………………………………………….8 References…………………………………………………………………………………9 Introduction Financial engineers have developed a number securities and derivates such as futures and contracts, these financial derivatives can be used in hedging and as risk mitigation strategies.

In order to offer delineation of how financial derivates helps firm in militating against losses that may occur due to changes in market factors below is report on cooper works, outlining and delineating the process of is management through derivatives. Designing of the hedging strategy Hedging can simply be defined as mechanism of shielding the firm against losses that may occur due to changes in the market parameters. In the case of copper works the firm annual demand of cooper is vulnerable to the prices change, in the process of the interaction of the demand and supply of cooper.

For the firm to mitigate price volatility which is beyond the control of the firm there is needed for the firm to buyer futures contract that would enable the firm hedge against the changes in prices of cooper. As policy of the firm to hedge 80% of its exposure therefore with each contract having a capacity of 25000 pounds then we can only hedge against 800000 pounds, equivalent to 32 contracts. In reference to the nature of the cooper market it was advisable to take long position on all futures contract, in addition to this the organization should have two future trade open at same as asset management technique to mitigate against sever losses that would otherwise occur if prices of future contract declined significantly.

An assessment of the impact of the above hedging strategy Go Long for 32 contracts @ 372.30 cents Initial margin = $64000 Maintenance margin = $48000 Date Price futures contract in cents Profit/ loss Margin Account Notes October 2010 372.30 - $64000 February 2011 369.0 -$26400 $37600 Take $10400 to reinstate the margin level February 2011 370.2 - $48000 August 2011 365.00 -$41600 $6400 Take $41600 from cash to reinstate the margin level August 2011 364.80 - $4800 February 2012 377.00 $97600 $145600 February 2012 376.

50 - August 2012 388.00 $92000 $237600 Total Gross profit/loss = $121,600 From the above the initial margin level can be estimated as follows, Initial margin level = 2000x 40x0.8= $ 64000 From the analysis above there are two margin calls to reinstate the maintenance level the total. Margin calls can be ascertained to be 10400+41600= 52000 should obtain from the cash deposited by the cash broker. Advantages and disadvantages of futures contract Many financial derivatives are primarily to mitigates the from risk but on top of this derivates also have the following benefits to the firm, 1.

In future contract parties have