A firm has invested in corporate bonds it may engage in a financial futures contract in order to protect itself from what.
What are your choices?
asdad
In order to protect itself from interest rate risk, a firm may engage in a financial futures contract.
To understand why this is the case, let me explain the relationship between corporate bonds, interest rates, and financial futures contracts.
When a firm invests in corporate bonds issued by other entities, it essentially becomes a creditor, lending money to these entities in return for regular interest payments and the repayment of the principal amount at maturity. The interest payments on corporate bonds are usually fixed for a specific period of time.
However, interest rates in the market are subject to change due to various economic factors. If interest rates rise after a firm has invested in corporate bonds, the value of those bonds in the secondary market may decrease. This is because investors can now get higher yields by investing in newly issued bonds with higher interest rates.
This is where financial futures contracts come into play. Financial futures are standardized contracts traded on exchanges that allow participants to buy or sell financial instruments at a predetermined price and date in the future. In the context of interest rates, firms can use interest rate futures contracts to hedge against potential losses resulting from adverse interest rate movements.
To protect itself from the risk of rising interest rates, a firm can enter into a financial futures contract to sell interest rate futures. If interest rates do rise, the value of the portfolio of the firm's corporate bonds may decrease, but the gain on the futures contract would offset this loss. Essentially, the firm would profit from the futures contract if the value of the bonds declines due to rising interest rates.
By engaging in a financial futures contract, the firm effectively hedges its position, as any losses on their corporate bond investment would be offset by the gains on the futures contract. This helps protect the firm's overall portfolio from interest rate risk.
It is important to note that engaging in financial futures contracts involves market speculation and can be complex. Therefore, it is recommended that firms seek professional advice from financial experts or risk managers to properly analyze and manage their exposure to interest rate risk.
a.) Inflation
b.)rising interest rates
c.)change in hedging activities
d.) declining interest rates