CORPORATE FINANCE AND RISK MANAGEMENT

CORE CONCEPTS IN CORPORATE FINANCE.

  1. Forward contracts.

This is a market for currencies that enables a MNC to lock in the exchange rate(forward rate) at which it buys or sells a currency.it specifies the amount of a particular currency that will be purchased or sold by a MNC at a specified future point in time and at a particular change rate.

  1. Currency future contracts.

They are similar to forward contract expect that they are sold at an exchange market (e.g. NSE) where forward contracts are offered   by commercial banks. They specify a standard volume of a particular currency to be exchanged on a specific settlement date.

  1. Currency option contracts.

An option is an agreement between a holder (buyer) and a writer (seller) that gives the holder the right but not an obligation to buy or sell financial instrument at any time at a specified date/period.

They are classified as call or put.

  1. Currency call option-Provides the right to buy a specific currency at a specific price within a specified period of time. Used to hedge future payables (creditors).
  2. Currency put option-Provides the right to sell a specific currency at a specific price within a specified period of time. Used to hedge future receivables (debtors).
  3. Swaps-Parties agree to swap something, generally obligations to make specified payment stream. Most common ones are
  • Foreign currency swaps –This can be illustrated by a Kenyan firm that borrowed from England and hence needs to repay the loan plus the interest in Sterling pounds though its earnings are in Kshs while a company in England has issued a bond in Kenyan securities market and hence needs to repay in Kshs.This company can swap responsibilities and avoid exchange rate risk
  • Interest rate swaps-A transaction between two parties involving an exchange of one stream of interest (obligations) for another for specific maturity on a notional principal amount.

KEY TERMS

  1. Hedging-This is the process of covering up forex risk and involves taking of one risk to offset an equal and opposite risk.
  2. Speculation-Dealers in forex speculate future direction of currency movement. Appreciation of a currency will lead to high rates in the market thus more profits are earned.
  3. Arbitrage-Refers to simultaneous purchase and sale of a currency in order to get profit from exchange rate different in 2 countries or locations.

Risk management + Risks-Refer notes from lending.

Risks.

  • Asset back
  • Credit
  • Foreign
  • Liquidity
  • Market
  • Reputation
  • Legal
  • IT
  • Interest rate
  • Gearing ratio
  • Political
  • CommodityAssociated with commodity prices.
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