Management Essay

1255 Words Aug 21st, 2010 6 Pages
n the late 1990’s Enron held substantial investments in several high-tech companies. Many of these stocks soared in price after their initial public offering, which allowed Enron to report very large gains on its income statement.1 However, the stocks could not be sold and the gains realized in cash because the investments were subject to lock-up agreements.2 Enron’s Chief Financial Officer (CFO) and others realized it was likely these investments would experience significant drops in value before they could be sold, but the investments could not be hedged commercially. Therefore, the CFO designed transactions that would, from an accounting point of view, keep the anticipated losses out of Enron’s income statement. This paper explains …show more content…
2.0 Risk Management and Derivatives Used by Enron A complex global economy subjects multinational businesses to financial risks. Among these risks are changes in interest rates, foreign currency exchange rates, stock prices, and commodity prices. Derivatives are financial instruments designed to achieve certain economic results and are often used to help manage risk. A derivative’s value is derived from something else, which is referred to as the “underlying.” The underlying could be the price of a security or commodity, a rate, an index, or the price of another financial instrument. A derivative changes in value as the value of the underlying changes. The most common types of derivatives are futures, forwards, swaps, and options. Enron’s hedging transaction relied primarily on equity swaps, put options on equity investments, and collars, which are option-like instruments. 2.1 Futures and Forwards A futures contract is an exchange-traded legal contract to buy or sell a standard quantity of a commodity, financial instrument, or index at a specified future date or price. Futures, which allow companies to lock-in a future purchase or sales price, are generally used to help protect against changing commodity prices. They trade in standard quantities and for standard time periods. A forward contract is similar to a futures contract except that the

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