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Financial Risk ManagementOption Trading - Essay Example

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Market risk mostly tend to arise out of external events on which firm has very little or no control therefore market risk is often…
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Financial Risk ManagementOption Trading
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Download file to see previous pages Commodity risk arises from the potential movement in the underlying commodity and as such includes energy products as commodity. (Jorion, 2007). The speculative trading in options by CAO indicate that the company was betting too much on speculations about the movement in the prices of the oil in international market which however, did not happened positively all the time and company plunged into troubles. Historically, it has been observed that the energy products are relatively more volatile as compared to other commodities and as such unorganized speculative activity in such products definitely result into losses for the firms.
Credit Risk is another important aspect of overall risk management and firms have to relatively take care of the fact that credit worthiness of the parties with whom they are trading is good. Credit rating therefore plays a critical role in defining the future relationship of the counter parties to any transaction. The major role of credit ratings and credit rating agencies is therefore of providing an independent opinion based on certain specific criteria.(Servigny & Renault, 2004).
The analysis of the given facts will indicate that the firm attempted to involve itself in trade with companies whose credit worthiness was not good in the market. By trading on their behalf, CAO actually attempted to acquire the credit of risk of those companies whose overall credit risk was relatively higher as compared to other companies. CAO entered on behalf of the airlines by offering identical contract terms to counter parties and in return of premium waiver of those air lines, CAO basically assumed the credit risk of all such airlines. The involvement of back to back transactions itself indicated that the CAO was more than willing to assume the credit risk of these airlines however, with more volatile increase in the oil prices, the overall net exposure of CAO ...Download file to see next pagesRead More
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