Derivatives Used by Selective Companies (Term Paper Sample)

A) DERIVATIVES USED BY SELECTED COMPANIES
EQUITABLE BANK
This is a bank of Canadian origin founded in 1970. It has its main activities as lending for residential and commercial purposes. It has recently offered saving services and ranks among the biggest banks in Canada with an asset worth of $25 billion.
Hedging Interest rate risk
In retail banking there involves a lot of deposits and loaning. Profits are thus generated due to the difference between the interest on loans and deposits. They have thus been engaged in activities that hedge against risk of losses. Equitable Bank for instance has made use changes in interest rates to secure their profits. This is by buying future interest rates to secure itself from future changes that may hurt its profits (Varghese, 2017). They have also made used of pension funds to secure against defaulters. For instance the bank in 2008 made use of the pension funds to purchase a credit default swap (CDS) where they were to be paid in case their bond was to be worth less. In this hedge practices, the bank main objective was to protect its assets and the net profits of the firm in the future.
Commodity price risk
The bank has also taken risk. It is worth noting that in financial derivatives, one party takes risk while the other is protecting itself (Barrera, 2012). In the first case, Equitable Bank was protecting itself. There are other cases where it has been the risk taker. For instance, they have made use of commodity prices. In this case they have allowed their clients to purchase stock that is to be paid at an agreed price in a later date. In case the prices of the stock will be high, the bank would pay the price and if it would be low they would enjoy the premium. For instance in 2004, they were able to earn a premium of $4.8 billion on a 15 years put option contracts. In this case, the main objective of the bank has been to grow its operations as well as take risk in the presence of uncertainty.
CALAVO GROWERS INC
This is an international company incorporated in United States in 1924. It is mainly engaged in consumer goods and farm products. Thus it is engaged in packaging and distribution of avocados and other fruits as well as prepared food in different countries.
Hedging against commodity price risk
Since the firm has been engaged with highly perishable product with an estimated loss of about 30%, the firm has undertaken activities to hedge against this losses (Li & Hardy, 2011). They for instance made use of commodity price in 2009. In this instance in Mexico, they agreed a set future market price which was to be paid and due to phytosanitary complication in US tat year they were able to receive a premium. This hedging was undertaken since agricultural commodities are exposed to a lot of chemical residual and trade regulations which the fir needed to protect itself from in cases the prices were to fall.
Commodity price risk
The firm has also made use of commodity price to take risks. For instance they have paid an agreed advanced price to farmers in cases they stipulate the price of avocados may go up hurting their profits. The objective of this risk taking behaviour was due to the characteristic of agricultural commodities with are high volatile and perishable. Thus prices are hard to determine.
SOUTHWESTERN ENERGY
This is a natural gas and exploration corporation founded in United States in 1929. Its main activities involve production and distribution of energy and ranks among the largest energy producing companies with a net asset worth of $6.71 billion.
Hedging commodity price risk
The firm has been making use of commodity price to hedge against fall in fuel prices. The firms for instance benefits up to 16% of the fuel price due to their three years hedge against fall in prices (Varghese, 2017). In 2020, they have also protect themselves from a downside pressure and thus the main objective has been to leap high prices for the fuels. This has led to setting of floor and ceiling prices giving a boundary of operation. Thus the main objective of the hedge has been to secure the firm from price risk associated with high volatility.
Hedging exchange rate risk
The firm has a three year rolling hedging program to protect its returns in cases of changes in rates for different countries. This has been through use of fixed price swaps, two-way collars, three-way collars, and long puts. For instance, it has a fixed price swap at NYMEX (New York Mercantile Exchange). This has been set with a major objective of securing the firm’s profits. It has also a set of ceiling, floor, and striking prices to ensure it remains competitive.
PART B: USE OF TRADE OPTIONS TO LOWER RISK OF LOSS
EQUITABLE BANK
The bank has made use of futures as well as options to minimise its risks. For instance in relation to the exchange and interest rate risk, it has stock equity and credit options. They have the long credit default swap which has been to protect against defaulters. The credit swap is an agreement where the buyer is guaranteed of a compensation in case there is default (Bielecki & Rutkowski, 2013). The credit and the equity options are dependent on fall in prices that are bound to happen in future. Thus Equitable Bank has made use of the long future risk hedging to secure their profits. In the use of the swap, the firm has secured their bonds and debentures against future fall in prices.
The bank has also made use of forwards where they buy the interest rates for future gains. In this cases they have been attempting to maintain the rates and avoid instances it may be high hurting their profits. There has also been a great deal use of interest rate swaps to ensure they are able to protect themselves from future changes. Mainly in cases of future falls in interest rates, the bank has been using the swaps. The swap mainly works where two firms exchange their interest rates. Mainly, they are forward agreement and with zero coupon swap (Bingham & Kiesel, 2013).
Use of short Eurodollar futures has been a great deal for the bank to enable it hedge against future volatility in interest rates. This is a London interbank where banks are allowed to borrow in the London market. They are allowed to borrow at low rates to hedge against changes in interest rates. The lending involved $1 million for three months at low rates. The firm has concentrated mainly on the equity swaps of which they have secured their stock bonds, bills, and assets.
CALAVO GROWERS INC
The firm has engaged in futures mainly to hedge against price risk. Use of long price future has been the main strategy for use with farmers to ensure they give a predetermined contract price. The long price future is a trading contract where a price is set to be used in the future (Brown, 2001). The firm manages production and sets the price before the crop is ready for the market. The firm is obliged to buy the crop at that agreed price in the future. In the market they have also set prices as they deal with perishable commodities making futures the best option for them. In this case they are hedging against price risk in case the prices of the commodity in future were to fall.
They have also embraces the use of long call option due to the high v