Risk management and hedging

Risk management and hedging

1. 1. Which of the following are valid economic motives for a firm to hedge (vs leaving the exposure unhedged)?

   Reducing expected taxes via income smoothing (tax convexity)Reducing expected costs of financial distressStabilizing internal cash for funding positive-NPV investments without going to capital marketsMaking the firm worth more than the sum of its parts via MM I
2. 2. An airline using a 12-month forward contract on jet fuel at $2.00/gallon for next year's purchases is:

   Speculating on a fuel-price riseHedging — locking in next year's cost regardless of where the spot price goesReducing its tax shieldBorrowing at a higher rate
3. 3. Key difference between hedging via FORWARD and via at-the-money CALL OPTION:

   Forward costs premium up front; option doesn'tForward gives the firm a chance to profit if prices fall but caps losses if they riseOption costs premium up front; forward doesn't, but option preserves upside if prices move favorablyBoth are identical
4. 4. Which of the following are common patterns of BAD hedging?

   Speculation disguised as hedging (large directional bets unmatched to real exposures)Hedging an exposure the firm doesn't actually haveHedging an actual exposure to a level that costs more than the expected distress reductionHedging the same exposure with both forwards and futures