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| Name | Using Derivatives to Manage Risk: A Jargon Free Guide |
| Video Uploader | Video From CZ |
| Upload Date | This Video Uploaded At 14-01-2020 11:11:26 |
| Video Discription | What are derivatives and how can companies use them to manage prices more effectively? When people think of derivatives they often think of risk and speculation, basically a sophisticated Casino. In reality, when used correctly the opposite is true. At Czarnikow we use derivatives to help protect against price risk. You’re probably used to agreeing a fixed price when you buy or sell a product. This can feel like the most comfortable and risk free exchange, and is what we call a ‘spot trade’. In reality though, spot trades are considered to be the most risky. This is for two reasons: Firstly, if you want to set your price on the spot, you have to accept the price that the product is worth at that particular time. As markets fluctuate in price, waiting until you need delivery of a product might not be the optimal time to negotiate the price. Secondly, with spot trades one side of the deal tends to do better than the other, depending on the market at that time or who has the most bargaining power. To stop this from happening, we can use derivatives to empower both sides of the transaction to separately set price. This has many benefits. Firstly, you can set the price in advance of the trade itself (sometimes as far in advance as 3 or more years). So you’ll know how much money is coming in or going out, allowing you to plan accordingly. Secondly, both sides of the trade don’t have to act at the same time. This means they can price at a time that suits them – when the market is low for the buyer, and high for the seller, creating a win-win situation for both parties. And finally, a reduced focus on price means both sides are free to consider the ‘physical differential’. By this, we mean an additional fee or discount agreed between the two parties to reflect the quality of the product compared against the market standard, which could include product specifications, packaging, geographical locations and delivery terms. Importantly, this keeps the supplier and buyer relationship focused on value creation, avoiding confrontations about price. All of these advantages would be impossible with spot trading, but if it’s this simple, can anyone use derivatives trading? Sadly, it is a bit more complicated than that. In order to use derivatives, you must first set up your own futures account with the exchange or an account with a broker and then pay initial and variation margin calls on daily market movements. This can have a significant effect on cash flow. Furthermore, specialist hedge accounting standards must be adhered to, and if you want the derivatives to be in your domestic currency, you’ll also need to execute and manage currency derivatives. This is why working with a partner like Czarnikow is so important – we provide all the benefits of managing price risk through the futures market, without the complications and constraints that can be faced when dealing on the market directly. To find out more about how we can help, get in touch with us today. |
| Category | Education |
| Tags | derivatives | price risk management | czarnikow |
