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Due to the large number of derivatives deals that have publicly gone awry in the past, many organizations believe that derivatives increase risk rather than mitigate it. However, most derivatives are useful in risk management if used properly. This case p

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TEACHING OBJECTIVES:
Due to the large number of derivatives deals that have publicly gone awry in the past, many organizations believe that derivatives increase risk rather than mitigate it. However, most derivatives are useful in risk management if used properly. This case provides students who understand a simple interest rate swap with an opportunity to explore an exotic interest rate swap. The case provides enough information for the students to compute the payments involved during the life of an exotic interest rate swap. Although companies typically rely on bankers for such computations, understanding an exotic interest rate swap and its computation can help students to develop skills that will be useful when designing or negotiating such contracts. This case can be used to explore the following major aspects of using financial derivatives for risk management: 
*Exotic derivatives products and their associated pitfalls 
*The potential for derivatives to increase rather than decrease risk for a company 
*Derivatives mishaps
*The thin line between using derivatives for hedging risks and speculating on expected market movements
*Conflicts of interest between banks and companies 
* What motivates bankers and company executives to enter into complex derivatives transactions 

ASSIGNMENT QUESTIONS.
1. Analyze the swap structure and comment on whether MdP entered into a speculative transaction or one designed to reduce risk.
2. Compute MdP’s net cash flow on the payment dates.
3. What might motivate company executives and bankers to enter into such contracts?
4. Suggest methods to reduce the risk of derivatives mishaps in companies.

258 Words  1 Pages
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