Lesson: Hedges and Financial Products

Instructor: Nick Palazzolo

In this lesson, Nick Palazzolo, CPA, demystifies the complexities surrounding hedges and financial products, highlighting their critical role in financial risk management. He dives into the reasons entities might use hedging strategies, such as protecting against stock value fluctuations or potential spikes in fuel costs for airlines. Nick effortlessly simplifies concepts like swaptions, viewing them as akin to insurance policies to safeguard investments against adverse market movements. By equating these financial instruments to everyday insurance, Nick makes understanding options, futures, and forwards more relatable and easier to grasp.

Updated: May 31, 2022 Create an account

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Transcript

Instructor: Nick Palazzolo

Nick Palazzolo is head instructor of ExamPrep.ai CPA Review. Nick's teaching style is engaging & upbeat, combining practical Big 4 tax & assurance expertise with years of 1-on-1 coaching. His lessons are concise and emphasize what you need to know to pass. Whether you're a recent grad or working full-time, we’re confident you can conquer your CPA exams with Nick’s review.

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Hedges and financial products. Now what are hedges? And you might be familiar with these if you've taken FAR with us, right? What's a hedge? You want to hedge your bets.

Think of the phrase "hedge your bets". And why would you do this? Well, okay, I buy stocks, but there's a potential for those stocks to lose value. So I would buy some sort of hedge or an option to make sure that I'm not going to lose all my money on those stocks if I just want normal operations.

Maybe I am an airline and I want to hedge against fuel prices increasing incredibly. That would be very bad for my operations. So I'll buy a sort of option to increase in value if the underlying, which is my oil, increases in value as well. So these are just different options, different hedges.

We'll go over them. So a swaption is also known as a swap option. Just covering this quickly, it's to enter into an interest rate swap or some other type of swap. For an option's premium, the buyer would gain the right, but not the obligation, to enter into a specified swap agreement with the issuer on a specific future date.

Think of these as insurance policies. Actually, I'd say pretty much everything here can really be thought of as an insurance policy because that's what it is. Why do you buy insurance?

You buy insurance because you might get into a car accident, and well, I guess you're legally required to buy that anyway. So you buy that. You buy health insurance. You buy all these insurances because, well, if you get into an accident, if something happens, you have to pay all these bills. So you're hedging your bet. You are insuring if the worst were to happen.

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