Ross et al.: Fundamentals
of Corporate Finance, Sixth
Edition, Alternate EditionVIII. Topics in Corporate
Finance- Risk Management: An
Introduction to Financial
Engineering
(^806) © The McGraw−Hill
Companies, 2002
The reason for the increase in exchange rate volatility was the breakdown of the so-
called Bretton Woods accord. Under the Bretton Woods system, exchange rates were
fixed for the most part and significant changes occurred only rarely. As a result, im-
porters and exporters could predict with relative certainty what exchange rates were
likely to be in the future. In today’s post–Bretton Woods era, exchange rates are set by
market forces, and future exchange rates are very difficult to predict with precision.
Commodity Price Volatility
Commodity prices (the prices for basic goods and materials) are the third major area in
which volatility has risen. Oil is one of the most important commodities, and, as Figure
23.4 shows, oil prices have become increasingly uncertain since the early 1970s.
The behavior of oil prices is not unique; many other key commodities have experi-
enced increased volatility over the past two decades.
The Impact of Financial Risk:
The U.S. Savings and Loan Industry
The best-known example of the effect of financial risk is the collapse of the once-
thriving U.S. savings and loan, or S&L, industry. At one time, the S&L industry was rela-
tively simple. S&Ls accepted short-term deposits, and they made long-term, fixed-rate
780 PART EIGHT Topics in Corporate Finance
FIGURE 23.3
15 10151960 1965 1970 1975 1980 1985 1990 1995 50510Percent changeThe percentage changes in this figure are based on month-end rates.Source: Charles W. Smithson, Managing Financial Risk: A Guide to Derivative Products, Financial Engineering,
and Value Maximization,3rd ed. (New York: The McGraw-Hill Companies, 1998).Percentage Changes in the U.S. Dollar–Deutsche Mark Exchange Rate: 1960–97Applied Derivatives
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