Question

Due to the impact of COVID-19 on airways industry’s profitability, a commercial bank is concerned about the financial ability of borrowing companies in airways industry to serve the debt (repay loans). As a financial consultant, what type of derivatives you would recommend the bank to buy in order to hedge against this risk? Explain.

Answer 1

Derivatives I will be recommending the bank to buy, in order to hedge against this risk could be as follows-

A. I will be trying to ask these banks to take exposure into the stock futures of these companies which will be helpful in order to gain through the default of the debt if the company is going to falter then, shorting the stock futures, on these stocks can be helpful in order to realise the gaines.

B. Banking company can also take position in put options on these stocks because if these stocks are going to fall, it will mean that the company will be recovering from downside of these stocks by exercising the put options.

C. I will also be trying to advise them to take index futures because airline index feature will be representing the the overall Airlines companies and they will be taking put options as well as index futures on those Airlines indexes can be taken.

D. Banks can also enter into risk sharing agreements and it will be leading to various kinds of protection against any default of these banks.

E .These banks can also enter into credit default swaps and these defaults are to be sold to another company in exchange of a commission in order to save itself from default.

F. They can also take Short positions in forward contracts on the short side and if the stocks are going to fall the company is going to gain.