The Use of Derivatives to Hedge Market Risk in Corporate Financing

In this tutorial article, the strategies available to hedge market risks arising from different financing instruments are explained. Financial derivatives, whether futures or options have been widely applied in companies to mitigate or eliminate potential losses due to the uncertainty in interest or foreign exchange currency rates. However, the mathematical complexity of derivatives has sometimes been a barrier to non-highly specialised financial managers in understanding their foundations, advantages and ways to apply them in exposure reduction strategies. To address this issue, a practical approach to the use of derivatives is presented in this article. The swap valuation concepts and foundations of pricing are dealt with in the text, but their formal valuation techniques are described separately in the appendices. Explanations will be provided to calculate option premiums with the extensively used and free downloadable software of John Hull (Derivagem), but the mathematics involving the models used in option valuation will not be shown as they are outside the scope of this paper