Page 139 - DCOM507_STOCK_MARKET_OPERATIONS

Stock Market Operations

Notes Question:
Critically analyse the case study

Source: http://www.mercatusenergy.com/energy-hedging-case-studies/

6.8 Summary

Financial prices include foreign exchange rates, interest rates, commodity prices and equity
prices. The effect of changes in these prices on reported earnings can be overwhelming.

Companies attempt to hedge these price changes because they are risks that are peripheral
to the central business in which they operate.
By hedging, in the general sense, we can imagine the company entering into a transaction
whose sensitivity to movements in financial prices offsets the sensitivity of their core
business to such changes.
Hedging objectives vary widely from firm to firm, even though it appears to be a fairly
standard problem, on the face of it. And the spectrum of hedging instruments available to
the corporate Treasurer is becoming more complex every day.
The futures contracts overcome the problems faced by forward contracts, since futures
contracts are entered into under the supervision and control of an organised exchange.
The futures contracts are entered into for a wide variety of instruments like agricultural
commodities, minerals, industrial raw materials, financial instruments etc.

The forward and futures contracts are entered into for meeting the objects like hedging the
risk from price fluctuations, making profit from speculative and arbitrage opportunities,
price discovery of the future price.

The futures price is the market’s expectation of what the spot price will be on the delivery
date of the particular contract. The futures price comes close to spot price, when the
delivery date becomes due.

6.9 Keywords

Arbitrageurs: Arbitrageurs profit from price differential existing in two markets by
simultaneously operating in two different markets.

Economic Exposure: It refers to the impact of fluctuations in financial prices on the core business
of the firm.
Future Contract: A futures contract is a contract for delivery of a standard package of a standard
commodity or financial instrument at a specific date and place in the future but at a price that is
agreed when the contract is taken out.
Future Market: Futures Daily Settlement, or Marking to Market, is a complicated process that
takes place at the end of each trading day or trading period.
Hedging: A risk management strategy used in limiting or offsetting probability of loss from
fluctuations in the prices of commodities, currencies, or securities.

Speculators: Speculators are that class of investors who willingly take price risks to profit from
price changes in the underlying.
Transactional Risks: It reflects the pejorative impact of fluctuations in financial prices on the
cash flows that come from purchases or sales.
Translation Risks: It describes the changes in the value of a foreign asset due to changes in
financial prices, such as the foreign exchange rate.

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