Assume that you have just been hired as a financial analyst by Tennessee Sunshine Inc., a mid-sized Tennessee company that specializes increating exotic sauces from imported fruits and vegetables. The firm's CEO, Bill Stooksbury, recently returned from an industry corporate executive conference in San Francisco, and one of the sessions he attended was on the pressing need for smaller companies to institute corporate risk management programs. Since no one at Tennessee Sunshine is familiar with the basics of derivatives and corporate risk management, Stooksbury has asked you to prepare a brief report that the firm's executives could use to gain at least a cursory understanding of the topics.
To begin, you gathered some outside materials on derivatives and corporate risk management and used these materials to draft a list of pertinent questions that need to be answered. In fact, one possible approach to the paperis to use a question-and-answer format. Now that the questions have been drafted, you have to develop the answers.
Why might stockholders be indifferent whether or not a firm reduces the volatility of its cash flows?
What are six reasons risk management might increase the value of a corporation?
What is COSO? How does COSO define enterprise risk management?
Describe some of the risk events within the following major categories:
strategy and reputation
control and compliance
What are some actions that companies can take to minimize or reduce risk exposures?
What are forwards contracts? How can they be used to manage foreign exchange risk?
Describe how commodity futures markets can be used to reduce input price risk.
It is January and Tennessee Sunshine is considering issuing $5 million in bonds in June to raise capitalfor expansion. Currently the firm can issue 20-year bonds at a 7% coupon (with interest paid semi-annually), but interest rates on the rise and Stooksbury is concerned that long-term interest rates might rise by as much as 1% before June. You looked onine and found that June T-bond futures are trading at 111'25. What are the risks of not hedging, and how might TS hedge this exposure? In your analysis, consider what would happen if interest rates all increased by 1%.
What is a swap? Suppose two firms have different credit ratings. Firm Hi can borrow fixed at 11% and floating at Libor+1%. Firm Lo can borrow fied at 11.4% and floating at Libor+1.5%. Describe a floating versus fied interest rate swap between firms Hi and Lo in which Lo also makes a "side payment"of 45 basis points to Firm Hi.
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