P-1 Derivatives Summary (IA1 Valix) PDF

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P-1 DERIVATIVESDERIVATIVES Entities use derivatives financial instruments to manage financial risks such as: Change in commodity price Change in cash flows Foreign currency exposure Reduction of financial loss due to financial risk is the motivating factor in trading in derivatives. Derivatives crea...

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P-1 DERIVATIVES

DERIVATIVES

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Entities use derivatives financial instruments to manage financial risks such as: 1. Change in commodity price 2. Change in cash flows 3. Foreign currency exposure Reduction of financial loss due to financial risk is the motivating factor in trading in derivatives. Derivatives create rights and obligations that have the effect of transferring between the parties the financial risks.

TYPES OF FINANCIAL RISKS 1. PRICE RISK – the uncertainty about the future price of an asset. a. Entities are exposed to this such as investments in trading securities, purchase commitments and equipment to be imported in future date. 2. CREDIT RISK – the uncertainty over whether a counterparty will honor the terms of the contract. a. Banks & other financial institutions are exposed to this by grating loans to borrowers. 3. Interest rate risk – the uncertainty about future interest rates and their impact on the cash flows & the fair value of instruments. a. Borrower with a variable-rate loan is exposed to this by the fluctuation of interest rates in the future. b. Borrower with fixed-rate loan is exposed to this because of the possibility that the interest rate will decrease. 4. Foreign currency risk – the uncertainty about future Philippine peso cash flows stemming from the asset & liabilities denominated in foreign currency/...