FINA2322EFG Tutorial 4

THE UNIVERSITY OF HONG KONG

HKU BUSINESS SCHOOL
FINA2322EFG – DERIVATIVES
SECOND SEMESTER, 2023-2024

Tutorial 4 –Risk management

ü Risk Management: Producers/Sellers

Inherent position: Long

Strategies (All involve short positions in underlying asset)

Payoff Equivalent strategy Characteristics
Short forward - Lock the revenue

Long put options - Higher cost

- Unlimited upside
potential
- Protected
downside risk

Buy collars - Trade upside

potential for
downside
protection
- Lower cost

Short call options - Reduce losses by

receiving
premium, from
trading away the
upside potential
 FINA2322EFG Tutorial 4

ü Risk Management: Buyers

Inherent position: Short

Strategies (All involve long positions in underlying asset)

Payoff Equivalent strategy Characteristics
Long Forward - Lock the cost

Long call options - Higher profit

when input
price is low,
protected
against high
cost

Sell collars - Trade potential

low cost to
protect
potential high
cost

Short put options - Reduce cost by

receiving
premium
 FINA2322EFG Tutorial 4

ü Adjusting the cost of insurance

• Adjusting strike prices
• Selling potential gains to reduce potential losses

ü Reasons for Risk Management

• Bankruptcy and distress costs
• Costly external financing
• Taxes
• Preservation of debt capacity
• Managerial risk aversion

ü Reasons Not to Hedge

• Transaction costs
• Expertise
• Costs of monitoring
• Complications (tax and accounting)
• Potential collateral requirements

ü Put Call Parity

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