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Lecture Financial risks management - Topic 10: Hedging commodity risk and CaR

In this chapter students understand and can recall: why changes in real exchange rates matter, how to measure competitive exposure, how to manage competitive exposure, How to manage country risk, real exchange rate appreciation, competitive exposure and loss due to exchange rate changes. | 1 Topic #10 Hedging Commodity Risk and CaR L. Gattis A Course in Risk Management Mcdonald 2nd Chapters 4 and 6 covers Commodity Futures and Arbitrage. 2 What Do Financial Risk Managers Do? (IMM) Identify risks that affects the viability of your firm Market Risks: Equity, Interest Rates, Currency, Commodity, Liquidity Risk, Basis Risk Credit Risks: Bond and counterparty default Measure exposure to identified risks Positions, VaR/CaR/EaR, Stress Tests Mitigate risks Layoff, Accept, Hedge, Hold Capital 3 Producers and buyers are exposed to commodity price risk Firms convert inputs into goods and services. output input commodity Producer Buyer Firms hedge to protect input costs Firms hedge to protect output prices 4 Goldiggers, Inc. – Short Forward Goldiggers is a gold-mining firm planning to sell gold in one year, receiving the spot price of gold on that day. The current spot price of gold is $405/oz The costs of gold mining are $380/oz. Management believes that gold prices will be between $350 and $500 next year with an expected value of $425. The one year forward price of gold is $420. If the company does not hedge the price of gold, what will be the possible profits per ounce. If the company hedges the price of gold, what will be the hedged profits per ounce. St Unhedged Profits Short Forward Profit Hedged Profit $350 St-380= -30 (F-St)=70 40 $420 St-380=+40 (F-St)=0 40 $500 St-380=120 (F-St)=-80 40 5 Goldiggers, Inc. – Long Put Suppose a 1-year put option on gold with a strike price of $420 has a premium of $8.77/oz. Be sure to account for the interest expense (r=5%) of the purchased option. Compute the hedged and unhedged profits St Unhedged Profits Put Profit Hedged Profit $350 St-380= -30 70-9.21=60.79 30.74 $420 St-380=+40 8.77*1.05=-9.21 30.74 $500 St-380=120 8.77*1.05=-9.21 110.76 6 Commodity buyers are short the commodity, so must take a long derivatives position hedge A buyer that faces price risk on an input has an inherent short position in this . | 1 Topic #10 Hedging Commodity Risk and CaR L. Gattis A Course in Risk Management Mcdonald 2nd Chapters 4 and 6 covers Commodity Futures and Arbitrage. 2 What Do Financial Risk Managers Do? (IMM) Identify risks that affects the viability of your firm Market Risks: Equity, Interest Rates, Currency, Commodity, Liquidity Risk, Basis Risk Credit Risks: Bond and counterparty default Measure exposure to identified risks Positions, VaR/CaR/EaR, Stress Tests Mitigate risks Layoff, Accept, Hedge, Hold Capital 3 Producers and buyers are exposed to commodity price risk Firms convert inputs into goods and services. output input commodity Producer Buyer Firms hedge to protect input costs Firms hedge to protect output prices 4 Goldiggers, Inc. – Short Forward Goldiggers is a gold-mining firm planning to sell gold in one year, receiving the spot price of gold on that day. The current spot price of gold is $405/oz The costs of gold mining are $380/oz. Management believes that gold prices will be .