Term
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Definition
| 1) Reduce Bankruptcy Costs 2) Reduce Payments to Stakeholders 3) Reduce Taxes |
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Term
| Primary Objective of Risk Management |
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Definition
| Eliminate costly lower tail outcomes, minimizing the likelihood of financial distress and preserving financial flexibility |
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Term
| Risk Management in Practice |
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Definition
| Large firms hedge more than small firms and they typically hedge specific transactions, not overall risk. Hedge more if market is moving against them, not as likely to give up gains |
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Term
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Definition
| bet that oil futures would continue to exhibit backwardation - futures price was below expected future spot price. Spot prices fell, leading to paper losses. Mark to Market cause panic and liquidation |
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Term
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Definition
| Management's view on exchange rate led them not hedge against exchange rate risk, resulting in losses when it moved unfavorably. |
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Term
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Definition
| Companies should use speculative hedging unless they have a comparative advantage/inside knowledge |
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Term
| Three types of capital structure |
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Definition
| 1) Highly rated with low debt to equity ratio 2) Low rated with significant probablity of distress 3) Firm in Distress |
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Term
| Risk Management for Highly Rated |
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Definition
| May want to increase debt and subsitute risk management for equity capital |
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Term
| Risk Management for low rated |
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Definition
| Should Actively Engage in Risk Management to avoid distress |
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Term
| Risk Management for firm in distress |
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Definition
| Should not hedge, since gains go to debt holders anyway. Should aggressively take on more risk, upside could benefit shareholders, already in distress |
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Term
| Management Incentives/Principle Agent problem |
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Definition
| Degree of management hedging closely related impact on their compensation |
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Term
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Definition
| We are X% certain we will not lose more than V $ in N days" |
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Term
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Definition
| 1) Theorically good for any time period, but you do not have enough samples for longer periods such as a year 2) Uses normal distributions, whose tails are typically smaller than real world |
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Term
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Definition
| Cashflow simulations/Dynamic Financial Analysis can use correlations and non-normal distributions |
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Term
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Definition
| 1) Gains from risk taking activities must be measured on a risk adjusted basis 2) Compensation systems should be designed so managers are not compensationed for taking more risk, only for risk adjusted returns. |
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