Title of Paper: Reducing Company Pension Plan Risks using Derivatives

Name: Neil Ramsarran

Course Name and Number: FIN672: Financial Instruments and Derivatives
(MUB102DS)
Instructor Name: Geoffrey VanderPal
Date: 13-Feb-2021
It would be in my, and my company's, best interest as Chief Financial Officer to reduce the economic

risks of the entity to the best of my ability. My institution's profitability and overall financial health

would be improved by reducing the risks of unfavorable interest rates, currency volatility and other

variable economic risks. The corporation for which I work is a multinational organization headquartered

in New York, NY, with branches in Japan, Singapore, Germany, Spain and the United States. Our agency

has banking relationships in all of the countries listed above. The pension scheme of our business is

located near our headquarters and is traded publicly in the S&P 500 stock index. Additionally, with a 60

percent and 40 percent split, the pension plan has an Intermediate Corporate Bond Index.

My business, Empire Capital, is a New York, NY-based real estate investment firm that was founded in

the 1950's. The business invests in a variety of asset groups, from commercial offices to multifamily

offices to hotels across the globe. Empire Capital serves as a trustee for a variety of the assets under its

umbrella and provides its clients with weekly, quarterly and annual reporting of the financial assets of

the properties. Empire Capital also hires asset managers within the organization in accordance with
periodic financial statements to ensure that its managed assets operate smoothly on a regular basis by

tracking property operation, expenditures on capital expenditure, building projects, and any other major

projects/events requiring additional support. Empire Capital also acts as a lender on a range of equity,

mezzanine and senior hotel loans worldwide, as well as a lender on several of its corporate, multi-family

and development ventures.

Since my business operates in the global market as both a lender and a borrower, it is important for

myself and my finance team to analyze and try to reduce their financial risk regularly and accurately. It is

best to minimize and decrease risk here through a hedging maneuver with regard to global interest rate

risk. Hedging, by the use of derivatives, is most notoriously involved in the mechanism of reducing

interest rate risks. My business owns both shares and bonds, has financial operation in a variety of

currencies, and uses interest rates, so derivatives are a perfect tool to be used by Enterprise to minimize

risk. It is important to distinguish between reducing and fully removing risk entirely when addressing

risk. The risk mitigation act typically requires the use of a variety of different financial strategies aimed at

projecting business activity to enable profits to change in the favor of a corporation. The act of reducing

risk completely will also, almost entirely, reduce profits. This is why, when an investor is interested in

the use of derivatives for some of their underlying assets, there will always be at least a certain amount

of risk present.

The risk exposure of Empire Capital is very high as it does not have any derivatives currently in place to

protect against its properties. As the coronavirus (COVID-19) pandemic has not slowed yet, the present

state of the global economy is becoming increasingly unpredictable. Many industries, including the

industry of my business, have been adversely affected due to this crisis. Many of our hotel locations

have halted operations temporarily, pending notifications from local governments worldwide

indefinitely. As the U.S. government has waived landlord evictions in the face of the present turmoil in
the labor market, our multifamily apartment buildings expect delays in monthly rent payments.

Depending on the extent of the workforce hiatus around the world, our commercial offices can undergo

a similar feat. All in all, as market activity is slowing interest rates, my business must dramatically and

quickly minimize its risk exposure across the world as it is not in the entity's favor.

Examples of a few methods that Empire Capital can use to hedge its risk are forward rate deals, futures

contracts, interest rate swaps and option contracts. Currently, Enterprise has released a variety of fixed

interest rate bonds. Currently, the interest rate is the same as the market interest rate, so the bond is

priced at its maximum value. Interest rates have declined since the beginning of the global pandemic

and are projected to continue to do so. Market panic has also helped with this fall. Enterprise is

currently profiting from this because it now has just a smaller percentage of its overall bond value to pay

its investors on a periodic basis, even though the value of the bond is rising. If prices were to shift in the

opposite direction, which the firm could anticipate until the pandemic resides in the next few months,

then Empire Capital will be wise to use a forward rate agreement. In a few months, the presumption can

be made that prices will return to near to normal so that my business can protect against potential risk

by participating in a forward rate agreement. This deal will be between some private party who would

like to make an interest rate bet. If prices rise, as my business expects, we will benefit from this

arrangement, but if they decline, this agreement will benefit the other party. However, since my

business still has a number of active bonds on the market, we will benefit from the rise in our bonds,

even if the forward contract proves to be unfavorable. Interest rate swaps would be a savvy tactic to use

in an effort to minimize risk in situations where Empire Capital is an investor in an asset. Swapping a

variable rate for a fixed rate will prove to be a sound decision in times of volatility and vice versa.

It would be most rational for the company to use option derivatives for equity investments in which

Empire Capital acts as an investor, namely stocks, in order to hedge its risk. We will exercise the option
to buy puts with a fixed strike price on any shares that my business owns where we can reasonably

reliably conclude there is a high-level chance that the stock will decline. Here, in exchange for paying for

a number of puts, we are hedging some market risk to provide us with the opportunity to sell our stock

once it goes below a certain price that will no longer give our investment a return. As we should expect

to see a big drop in stock prices, I would urge Empire Capital to buy these put options. Since the massive

fall in share prices is behind us, we can more effectively employ call options. This derivative will give us

the opportunity to buy Stock at a specified price in the specified period. When the stock market

continues to reach normalcy, this would be most useful. Empire Capital will lock in more attractive prices

and would be able to buy stocks at a cheaper price than what is being sold to the market until they are

worth more.

Another growing problem for my organization is currency volatility, as my company actively trades a

variety of foreign currencies across the world. In attempting to leverage risk against volatility, currency

rate swaps are derivatives that come in handy. An arrangement between two parties to exchange the

principal amount of a loan and the interest in one currency for the principal and the interest in another

currency is a currency exchange rate swap (Definition from ACCA). A currency swap would use a similar

strategy, much like an interest rate swap, but it would require more than one currency. These are very

useful in determining the uncertainty in international markets in which Empire Capital has shares, i.e.

Japan, Singapore, Spain, Germany and the United States. Since the most extreme effects of coronavirus

are faced by many Asian countries, it would be wise to employ currency swaps in Japan and Singapore

with countries like Germany and the United States. I would promote currency exchanges between Spain

and a more prosperous nation (like Germany or the United States), as well as a rise in the number of

infected citizens in the country, which would eventually lead to greater market instability. However,

with the current state of the economy, this derivative is difficult to use because there is new public

information being exchanged on a regular basis that can change the volatility of the currency of a nation
on a material scale. The number of cases in the United States, for instance, is currently gradually

growing, with New York being the epicenter for 5% of world cases, which would make it harder for

investors to swap in favor of or against the US dollar.

In short, I would argue that a variety of derivatives would consist of the best derivative management

program to employ for Empire Capital to provide hedging scenarios that benefit market movements in

either direction. As stated before, it would be better to use interest rate risk aversion swaps for interest

rate risk aversion, for currency rate risk aversion, I will advise it best to use currency rate swaps, and if

exercised correctly, derivative options would prove to be profitable for equity risk aversion. It should be

noted that a good derivative management program must be a constructive one because the maxim "one

size fits all" does not apply to our assets or to the assets of any organization in that regard. The secret to

success here will be the responsiveness to make active and informed decisions based on market activity

by myself and my team. For example, knowing when currency swaps should take place and what

currencies we should exchange for will be crucial. It is also important to be able to discern when it would

be a good time to turn from a variable to a fixed interest rate. As far as portfolio insurance goes, it would

be important to know when to employ a call or a put option for stocks that we are trying to buy or sell.

Much of the weight will fall on the timing, responsiveness and derivative expertise of the finance team

of our business in handling this risk.