Why do companies deviate from maturity-range hedging?

Companies deviate from maturity-range hedging for three primary reasons:

(1) Inability to obtain the desired financing – Small businesses often cannot obtain funds in the maturities needed for hedging purposes. They have difficulty raising long-term capital and tend to weight their financing toward the available shorter-term trade credit and bank financing.

(2) Cost reduction (higher returns) – Some companies elect to use more short-term financing than required for hedging since it is lest costly when yield curves are normal. Other companies elect to use more long-term debt to avoid the costs of repeatedly renewing and renegotiating their financing.

(3) Risk reduction – Some companies elect to use more short-term financing than required for hedging since it gives them a high degree of flexibility in adding and subtracting debt from the balance sheet should their needs change. Other companies elect to use more long-term debt to lock in interest rates, improve their credit ratings, and avoid the danger of bankruptcy from having to repay debt on an ongoing basis.

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Posted by MbaNotesWorld - December 7, 2017 at 8:23 pm

Categories: Financial Management   Tags:

Which financial instruments are most commonly used as marketable securities?

These securities include U.S. Treasury bills, bonds and notes; bonds issued by other federal agencies and by state and local governments; bank instruments including acceptances, negotiable CDs, and repos; financial market instruments such as commercial paper, Euronotes, and variable-rate preferred stock; and money market mutual funds combining securities from one or more issuers. They all share the characteristics of relatively low risk and high liquidity and marketability.

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Posted by MbaNotesWorld - December 6, 2017 at 8:18 pm

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Composition of a portfolio of marketable securities

What factor(s) enter the decisions about the composition of a portfolio of marketable securities?

The important factor is the maturity of each security in the portfolio. Marketable securities should be selected with an eye toward when the money will be needed again in order to insulate the company from market price fluctuations. In this way, the company will receive a known face value when each security matures. Since the values of all marketable securities in an economy are closely tied to interest rates, it is not possible to use statistical portfolio techniques (betas) to reduce the risk of this kind of portfolio.

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Posted by MbaNotesWorld - December 5, 2017 at 7:46 pm

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What is meant by the “five Cs”?

The five Cs are five words that summarize the criteria for extending credit used by commercial banks. Specifically, they are:

a. Character does the credit applicant responsibly meet his/her obligations?

b. Capacity does the credit applicant have the ability to pay?

c. Capital does the credit applicant have sufficient resources to make payments under adverse conditions?

d. Collateral does the credit applicant have assets which can be pledged against the loan to provide a “second way out” should payment not be made?

e. Conditions what outside factors may make it difficult for the credit applicant to pay and what is the probability and projected effect of each?

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Posted by MbaNotesWorld - December 4, 2017 at 7:13 pm

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Forward contracts another kind of derivative security

Some financial professionals consider forward contracts another kind of derivative security. Why do you think this is so?

A derivative security is a contract whose value is tied to some financial market security, rate, or price. These financial professionals see forward contracts as fitting within the definition of a derivative, since the value of a forward contract depends on the interest or exchange rate it is connected to. For example, a company which has signed a forward exchange contract has the obligation to purchase a foreign currency at a specified exchange rate. Should the foreign currency become more expensive, the forward contract would become more valuable and vice versa.

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Posted by MbaNotesWorld - December 3, 2017 at 6:47 pm

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Quality-leading companies

In what way(s) are quality-leading companies changing their approach to the control of working capital?

Quality-leading companies are finding many ways to improve their production, finance, and management processes to significantly reduce working capital requirements. The move toward just-in-time manufacturing is perhaps the most visible of these improvements reducing the need for inventories the chapter relates the progress that one company, American Standard, has made in this regard. Other changes which have reduced the need for working capital include more efficient cash management through customer-supplier alignments with banks, and more efficient handling of receivables and payables by using electronic data interchange with suppliers and customers.

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Posted by MbaNotesWorld - December 2, 2017 at 6:40 pm

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How does a forward contract work as a hedging device?

A forward contract locks in an interest rate or exchange rate for a specified future time. It insulates the company from changes to that rate until the exercise date of the contract. Consider, for example, a company with an account receivable of 10,000 Swiss francs due to be collected in 90 days. The company will have to convert the francs to dollars at that time, but the exchange rate 90 days from now is unknown hence the company faces foreign exchange risk. By purchasing a forward exchange contract, the company can guarantee the rate of exchange and eliminate the risk. The forward contract, a liability to deliver 10,000 francs in 90 days hedges the account receivable asset, the right to receive 10,000 francs in 90 days by providing a way for the company to use the proceeds from the asset and receive a known value.fi

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Posted by MbaNotesWorld - December 1, 2017 at 6:38 pm

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In efficient financial markets, all hedging devices should be perfect substitutes!

In general, alternative hedging devices are reasonably good substitutes for one another. However this statement is not quite true for at least three reasons:

(1) Not all hedging instruments convey the same rights and obligations. For example, a forward contract commits the parties to go through with the transaction while an option gives the choice of whether to proceed to the option holder.

(2) Not all hedging devices are taxed the same way.

(3) Money market hedges appear on the balance sheet as assets and offsetting liabilities while derivative securities do not.

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Posted by MbaNotesWorld - November 30, 2017 at 6:28 pm

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How does a derivative security work as a hedging device?

Financial managers can use a derivative security to hedge the asset to which the derivative is connected by creating an opposite exposure to the asset. For example, a food processor could buy futures on the agricultural products it will be purchasing in the next few months. If the cost of the products rises the food processor will have to pay more for them, but the futures contracts will increase in value as well offsetting the extra cost and providing the additional money required. The asset and the derivative position are perfectly negatively correlated in this strategy: any change in value of the asset will be offset by an opposite change in value of the derivative security. In the ideal hedge, the opposite exposure is for the same amount of money as the asset itself, however, since derivative instruments come in fixed sizes for example $10,000 units it is often difficult to construct an opposite position of precisely the needed amount.

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Posted by MbaNotesWorld - November 29, 2017 at 6:14 pm

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Strategy

The term strategy has entered the management literature comparatively much later than its use in Military Science. Game theorists have used strategy-in the same sense in which the term policy was used earlier. Therefore, the concept of strategy and various actions involved are quite confusing and, sometimes, even contrasting. At first, the term strategy was used in management in terms of Military Science to mean what a manager does to offset actual or potential actions of competitors. The term is still being used in the same sense though by few only. Originally, the term strategy has been derived from Greek word ‘strategos’ which means general. The word strategy, therefore, means the art of general.

When the term strategy is used in military sense, it refers to actions that can be taken in the light of action taken by opposite party. According to the Oxford Dictionary, ‘military strategy is the art of so moving or disposing the instruments of warfare (troops, ships, aircrafts, missiles, etc.) as to impose upon the enemy the place, time and conditions for fighting by oneself. Strategy ends, or yields to tactics when actual contact with enemy is made.

In management, the concept of strategy is mostly taken in a slightly different form rather than in military form; it is taken more broadly. However, even in this form, various experts of the field do not agree about the precise scope of strategy. In earlier views, strategy was taken in a very comprehensive way.

For example, Chandler, who made a comprehensive analysis of the interrelationship among the environment, strategy, and organization structure has defined the term strategy in 1962 as follows:

“Strategy is the determination of the basic long-term goals and objectives of an enterprise and the adoption of the course of action and the allocation of resources necessary for carrying out these goals.”

Professors at Harvard Business School who have made considerable contributions in the development of strategic management have held similar views. One of them (Andrews) has defined strategy as follows:

Strategy is the pattern of objectives, purpose or goals and major policies and plans for achieving these goals, stated in such a way, so as to define what business the company is in or is to be and the kind of company it is or is to be.

The above two definitions of strategy are quite comprehensive and include objective setting as part of strategy. As against this, Stanford Research Institute, USA takes a different view when it states that strategy is a way in which the firm, reacting to its environment, deploys its principal resources and marshals its main efforts in pursuit of its purpose. Glueck who defines strategy as follows holds almost similar view:

“A strategy is a unified, comprehensive, and integrated plan relating the strategic advantages of the firm to the challenges of the environment. It is designed to ensure that the basic objectives of the enterprise are achieved.

Two approaches of defining strategy, particularly in terms of the actions included in strategy, are different with former approach including objective setting as part of the strategy while latter excluding it. This difference is likely to continue unless we arrive at universally acceptable concept of strategy. For the purpose of this text, strategy is defined as follows:

Strategy is course of action through which an organization relates itself with envi-ronment so as to achieve its objectives.

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Posted by MbaNotesWorld - November 28, 2017 at 5:55 pm

Categories: Strategic Management   Tags:

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