Introduction to Corporate Finance

Ross et al.: Fundamentals

of Corporate Finance, Sixth

Edition, Alternate Edition

VIII. Topics in Corporate

Finance

23. Risk Management: An
    Introduction to Financial
    Engineering

© The McGraw−Hill^815

Companies, 2002

Credit Risk Another important thing to remember is that with a forward contract, no
money changes hands when the contract is initiated. The contract is simply an agreement
to transact in the future, so there is no up-front cost to the contract. However, because a
forward contract is a financial obligation, there is credit risk. When the settlement date
arrives, the party on the losing end of the contract has a significant incentive to default on

CHAPTER 23 Risk Management: An Introduction to Financial Engineering 789

FIGURE 23.8

Risk Profile for an Oil

Buyer

Poil

V

Risk profile

FIGURE 23.9

Hedging with Forward

Contracts

Risk

profile

Poil

V

Payoff profile

for forward contract

Resulting

exposure