Assume you have just been hired as a financial analyst by Tennessee Sunshine Inc., a mid-sized Tennessee company that specializes in creating exotic sauces from imported fruits and vegetables. The firm's CEO, Bill Stooksbury, recently returned from an industry corporate executive conference in San Francisco, and one of the sessions he attended was on the pressing need for smaller companies to institute corporate risk management programs. Since no one at Tennessee Sunshine is familiar with the basics of derivatives and corporate risk management, Stooksbury has asked you to prepare a brief report that the firm's executives could use to gain at least a cursory understanding of the topics. To begin, you gathered some outside materials on derivatives and corporate risk management and used these materials to draft a list of pertinent questions that need to be answered. In fact, one possible approach to the paper is to use a question-and-answer format. Now that the questions have been drafted, you have to develop the answers
a. Why might stockholders be indifferent to whether or not a firm reduces the volatility of its cash flows?
b. What are six reasons risk management might increase the value of a corporation?
c. What is corporate risk management? Why is it important to all firms?
d. Risks that firms face can be categorized in many ways. Define the following types of risk:
(1) Speculative risks
(2) Pure risks
(3) Demand risks
(4) Input risks
(5) Financial risks
(6) Property risks
(7) Personnel risks
(8) Environmental risks
(9) Liability risks
(10) Insurable risks
e. What are the three steps of corporate risk management?
f. What are some actions that companies can take to minimize or reduce risk exposures?
g. What is financial risk exposure? Describe the following concepts and techniques that can be used to reduce financial risks:
(1) Derivatives
(2) Futures markets
(3) Hedging
(4) Swaps
h. Describe how commodity futures markets can be used to reduce input price risk.
i. It is January, and Tennessee Sunshine is considering issuing $5 million in bonds in June to raise capital for an expansion. Currently, the firm can issue 20-year bonds with a 7% coupon (with interest paid semiannually), but interest rates are on the rise and Stooksbury is concerned that long-term interest rates might rise by as much as 1% before June. You looked online and found that June T-bond futures are trading at 111′25. What are the risks of not hedging, and how might TS hedge this exposure? In your analysis, consider what would happen if interest rates all increased by 1%