Risk Management, Treasury, and Financial Instruments
Risk Management, Treasury, and Financial Instruments tests whether you can identify an exposure, choose a hedge, and account for it - and whether you understand precisely what a hedge fixes and what it does not.
Core rules
- FX exposure has three forms: transaction (committed foreign-currency cash flows), translation (foreign operations' statements), and economic (competitive position). Hedging one does not neutralize the others.
- Instruments: forwards fix a rate; futures are standardized and marked to market daily with margin calls; options cap downside for a premium; swaps exchange fixed for floating interest or one currency for another.
- Interest rate risk: duration measures price sensitivity; a borrower fearing higher rates can pay fixed via a swap, buy a cap, or lock in with an FRA.
- Hedge accounting under IFRS 9 requires documentation, an economic relationship, and effectiveness. A cash flow hedge sends the effective gain or loss to OCI and recycles it to profit when the hedged item affects profit; a fair value hedge adjusts profit immediately.
- Treasury fundamentals: rolling cash forecasts, liquidity buffers, covenant headroom monitoring, counterparty credit limits, and segregation of duties between dealing and settlement.
Worked example
A Canadian exporter will receive US$1,000,000 in 90 days. Spot is 1.3400 and the 90-day forward is 1.3475, so selling forward locks in C$1,347,500. If spot falls to 1.3200, the unhedged result would be C$1,320,000 - the hedge preserved C$27,500. If spot rises to 1.3700, the hedge forgoes C$22,500. The forward removes variance, not opportunity cost. If the receivable is a highly probable forecast transaction, designate the forward as a cash flow hedge so the effective OCI gain is released to earnings in the same period as the sale.
Traps that cost marks
- Netting exposures that differ in currency, amount, or timing.
- Judging a hedge after the fact against the ex-post spot rate as if variance reduction were a failure.
- Assuming any derivative qualifies for hedge accounting without documentation and effectiveness testing.
- Comparing a forward with an option without netting out the premium or forward points.
- Forgetting the basis adjustment when hedging forecast inventory purchases.