Reference no: EM131070527

Financial managers may want to protect their corporation against the financial risks that a fluctuation in the market price of cost drives or other company fundamentals. A commercial airliner whose operating cost is 25-30 % depended on the price of jet fuel may want to safeguard against the fluctuation of the price of crude oil. A US corporation having anywhere between 15-20 % of its sales in Canadian Dollars may want to safeguard against the currency fluctuation. A textile wholesaler specializing in knits, whose products typically contain 35-100 % cotton may want to safeguard against the fluctuation in the price of cotton. The managers entrusted with the financial management of these corporations may decide to institute programs that would enable to hedge all or part of the company’s exposure to the above cost drivers or currency exposures for the respective firms. Is there any methodology by which we can predict within certain parametersthe price ranges of the abovementioned cost drivers or fundamentals? What financial instruments should the respective managers purchase? Should the manager buy one such financial instrument or should they layer them based on respective value and length of time? What would be advantages and dis-advantages on either side? Many derivatives and hedging financial instruments are typically private agreements between a financial institution and a corporation. These derivatives stand in the boarder of Private Markets (prime financial instrument example for these markets, Asset Backed Corporate Loan), and public markets (prime examples of financial instrument examples for these markets are publicly traded corporate stocks and bonds). Typically these derivative financial instruments will not be embodied into securities and traded, so they are not required to be standardized. Nevertheless the Financial Industry does in effect apply such standardization. Often the contract of these financial instruments has a non-negotiable master agreement and then ISDA suggested clauses which are standardized in the agreement between the offer of the derivative (typically an investment bank, a commercial bank or a corporate financial services provider). What are some major benefits of this standardization? What are the financial institution achieving in standardizing all such contracts with a specific client?