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In DCF model, unsystematic risk may lower the expected cash flows
Analyze the historical data on firm value, cash flows and financial prices.
Regress past changes in firm value (or its cash flow) against past
+ e ∆Inflation ratet
(exchange rate, interest rate, oil price, inflation rate) reflects the
firm’s cash flow exposure to that variable
ILLUSTRATION
SIMULATION
FORWARDS / FUTURES
Forwards
Definition:
Example:
F = Futures Price
S = Spot Price
C = Cost of Carry = Interest Cost, since the Cost of Carry
for Finance is Interest cost.
F = S(1 + r)t
r = Rate of Interest
t = Tenure of the futures contract
OPTIONS
OPTIONS
Call Option (Buyer): It gives the buyer the right but not
the obligation to buy the underlying at a particular date at
an agreed upon price today.
Put Option (Buyer): It gives the buyer the right but not
the obligation to sell the underlying at a particular date at
an agreed upon price today.
Exposure = 20,00,000
Beta = 0.76
Nifty = 4500
Lot Size = 200
Scenario:
The person will have to buy Rs 229187.5 of futures value in order to balance the
hedge
HEDGING WHEN UNDERLYING EXPOSURE
Example:
Exposure = 20,00,000
Beta = 0.2217
Futures Contract (Heating Oil) = 100
Lot Size = 200
Time Decay Mixed – Hurts for Long Call and helps for Short Call
Use Bullish Outlook
Volatility Volatility Neutral
TYPE STRIKE PREMIUM
BUY PUT (A) 100 -10
SELL PUT (B) 120 20
View Comments
Profit Limited, Max Profit = Net Premium (20 – 10 = 10)
Loss Limited, Max Loss = (B – A) – Net Premium (120 – 100 - 10 = 10)
Breakeven Strike A + Max Loss (100 + 10 = 110)
Time Decay Mixed – Hurts for Long Put and helps for Short Put
Use Bullish Outlook
Volatility Volatility Neutral
TYPE STRIKE PREMIUM
BUY CALL (A) 120 -20
SELL CALL (B) 100 10
View Comments
Profit Limited, Max Profit = Net Premium (20 – 10 = 10)
Loss Limited, Max Loss = (B – A) – Net Premium (120 – 100 - 10 = 10)
Breakeven Strike A + Max Loss (120 - 10 = 110)
Time Decay TYPE – Hurts for Long
Mixed STRIKE PREMIUM
Call and helps for Short Call
Use BUY PUT
Bearish (A)
Outlook 100 -10
Volatility SELL PUT
Volatility (B)
Neutral 120 20
TYPE STRIKE PREMIUM
BUY PUT(A) 120 -20
SELL PUT (B) 100 10
View Comments
Profit Limited, Max Profit = Net Premium (20 – 10 = 10)
Loss Limited, Max Loss = (A– B) – Net Premium (120 – 100
Breakeven -Strike
10 = A10)
+ Max Loss (120 - 10 = 110)
Time Decay Mixed – Hurts for Long Put and helps for Short Put
Use Bearish Outlook
Volatility Volatility Neutral
TYPE STRIKE PREMIUM
BUY CALL (A) 100 -20
2 SELL CALL (B) 120 20
BUY CALL (C) 140 -5
View Comments
Profit Limited to [(C – B) – Net Premium] [(140 – 120) – 15]
Loss = 5
Limited to the extent of Net Premium paid
Breakeven Low BEP = Middle Strike – Profit
High BEP = Middle Strike + Profit
Time Decay Neutral
Use Large stock price movement unlikely .
Volatility Volatility Neutral
TYPE STRIKE PREMIUM
SELL CALL (A) 100 20
2 BUY CALL (B) 120 -20
SELL CALL (C) 140 5
View Comments
Profit Limited to the extent of Net Premium received
Loss Limited to [(C – B) – Net Premium] [(140 – 120) – 5] = -15
Breakeven Low BEP = Middle Strike – Loss
High BEP = Middle Strike + Loss
Time Decay Neutral
Use Large stock price movement expected .
Volatility Volatility Neutral
TYPE STRIKE PREMIUM
BUY CALL (A) 80 -20
SELL CALL (B) 100 10
SELL CALL (C) 120 5
BUY CALL (D) 140 -5
View Comments
Profit Limited, maximum when spot is between B and C
Loss Limited, maximum when spot is < A and >D
Breakeven Low BEP = B - Profit
High BEP = C + Profit
Time Decay Neutral
Use Large stock price movement unlikely.
Volatility Volatility Neutral
TYPE STRIKE PREMIUM
SELL CALL (A) 80 20
BUY CALL (B) 100 -10
BUY CALL (C) 120 -5
SELL CALL (D) 140 5
View Comments
Profit Limited, maximum when spot is < A and >D
Loss Limited, maximum when spot is between B and C
Breakeven Low BEP = B - Loss
High BEP = C + Loss
Time Decay Neutral
Use Large stock price movement expected.
Volatility Volatility Neutral
TYPE STRIKE PREMIUM
BUY CALL (A) 130 -20
SELL PUT (B) 100 10
View Comments
Profit Increases as the spot price increases
Loss Increases as the spot price decreases
Breakeven B + Net Premium
Time Decay Neutral
Use Large stock price movement expected.
Volatility Volatility Neutral
TYPE STRIKE PREMIUM
2 BUY CALL (A) 100 -40
BUY PUT (B) 100 -20
View Comments
Profit Unlimited
Loss Limited to the extent of premium paid
Breakeven Low BEP = Strike Price –Net Premium
High BEP = Strike Price + (Net Premium/2)
Time Decay Hurts
Use Expecting a large breakout. Uncertain about the
direction. Increase in the asset price more likely
Volatility Volatility Increase improves the position
TYPE STRIKE PREMIUM
BUY CALL (A) 100 -20
2 BUY PUT (B) 100 -40
View Comments
Profit Unlimited
Loss Limited to the extent of net premium paid
Breakeven Low BEP = Strike Price – (Net Premium/2)
High BEP = Strike Price + Net Premium
Time Decay Hurts
Use Expecting a large breakout. Uncertain about the direction. Decrease
in the asset price more likely
Volatility Volatility Increase improves the position
The trade: Buy NIFTY 4200 Put and Sell (Two lots) NIFTY 4000 Put
Rationale: Nifty futures have filled the upward gap that it formed on Monday
and have shown gap down opening today on the back of good volumes. Most of
the Nifty-50 stocks are trading in negative territory. We expect the Index to test
lower levels in the current series. Our strategy would be profitable in case Nifty
expires in the broad range of 4179-3821.
The company has study the markets to draw its own estimates of the
risks involved which would help it to negotiate with the bank better
The company has to approach the banker with its requirements. These
requirements has to be in terms of:
The net receivables or Payables
The level of risk protection needed
Other specific requirements
Steps for Hedging Currency
Exposure
The company has to cross check the rates given to it
by the banks. The rates that have to be checked are:
The company needs to get back the verified copy of the contract
leaving the duplicate with the banker
At the time specified in the contract the bank converts the positions
as per the terms agreed
Term Sheet
Structure Details:
Payoff Scenario:
Trade Date
Reset Date
Terms
LIBOR
Floating Rate
Fixed Rate
Spread
Interest Rate Swap
Meaning:
Fixed Floating
Intel 4.00% 6month LIBOR+0.3%
Microsoft 5.2% 6month LIBOR+1.0%
Transaction
4%
Intel Microsoft
LIBOR + 1%
Fixed Floating
Intel 4.00% 6month LIBOR+0.3%
Microsoft 5.2% 6month LIBOR+1.0%
Payoffs
Microsoft Intel
Pays LIBOR + 1% to Pays 4% to its outside
outside lenders lenders
Receives LIBOR under Pays LIBOR under the
the terms of Swaps terms of Swaps
Pays 3.95% under the Receives 3.95% under
terms of Swaps the terms of Swaps
Effectively net cash Effectively net cash
outflow of 4.95% (5.2%) outflow of LIBOR +0.05%
(LIBOR + 0.3%)
Banker’s Spread
In given case net gain was 0.5 which was distributed
between both the parties as 0.25 each. But if
bankers come into the picture then then will charge
around 0.02 from both the parties. So net gain for
both the parties would be 0.23 each and net gain for
the banker would be 0.02 + 0.02 = 0.04
Uses
Speculation
Reducing funding costs
Hedging interest rate exposure
Corporate finance
Risk management
Risks
Interest rate risk
Credit risk
Currency Swaps
Meaning:
USD AUD
USD AUD
Currency risk
Settlement risk
Credit default risk
Comparison of Interest Rate Swaps and Currency
Swaps
No exchange of
An exchange of
principal amount since
it is notional principal amount
Sources of
Finance
Costly Cash
Positive NPV
Investment
Corporate Value
Align risk management with corporate strategies
Appreciating 200
Stable 0
Depreciating -200
Impact of Hedging
Additional
R&D
Dollar Internal R&D without Hedge From Value from
Position Funds Hedging Payoff Hedging Hedging
Flexible Strategies
Growth Option
Switching Option
Focused Strategies
Uncertainty and Flexibility
Threatening Flexible
High
Situation Strategies
Focused Wasteful
Level of Low
Strategies Flexibility
Uncertainty
Low High
Use of Flexibility
Employ a Mix of Real and Financial Tools
Transaction cost
Complete hedging not possible
Risk factor
Risk Management
Do not put undue pressure on corporate treasuries
to generate profits
New telecom players will require ready towers for quick rollout and
establishing national experience
New entrants will opt for co-location in order to save their upfront
capex
Network quality concerns remain one of the primary reasons why
customers switch operators and the churn remains an important cost
driver for the operators.
A scarcity of spectrum and ever increasing subscriber base is
leading to poor quality network and frequent call drops
Industry Profile
MOU is increasing (presently MOU is about 464
min/month) leading to an increase in capacity
requirement for existing subscribers
We serve five pan India operators and three operators who
have bagged pan India licenses in the recent round of
allotments
RISKS AND SOLUTIONS
Business Concentration Risk: The risk of the a entire portion of
the company’s revenue coming from one source (Telecom
Towers)
Financial Risk:
Credit Risk: The risk of the customer not paying the company as
per the tenant lease.
Liquidity and Leverage Risk: The liquidity risk due to the company
being in the infrastructure business.
Limit the revenues from any single client to 10% of total revenue
Take sufficient insurance abroad to cover possible liabilities arising out of non
performance of the contract
Avoid contracts which have open ended legal obligations
Political Risks:
Explore the possibility of establishing development centers in
countries other than India