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Module Title: Finance Theory To Determine the Impact of How Risk Managers of Irish Financial and Non-Financial Institutions can Effectively Utilized Derivatives Contracts to Hedge Risk- („Risk Reduction‟) Dissertation submitted in part fulfilment of the requirements for the degree of M.Sc. in International Accounting and Finance @ Dublin Business School Adeniyi Adekoya 10131831 August 2015 Adeniyi Adekoya (10131831) Declaration I declare that this research is my original work and that it has never been presented to any institution or university for the award of Degree or Diploma. In addition, I have referenced correctly all literature and sources used in this work and this work is fully compliant with the Dublin Business School‟s academic honesty policy Signed: Adeniyi Adekoya Student No: (10131831) Date: 15th August 2015 Relevant word count: 25,000 approx. Supervisor Name: Mr. Enda Murphy 2 Adeniyi Adekoya (10131831) Acknowledgments Throughout this degree journey, I give all thanks to Almighty for sparing my life and my family members, blessing me with good health, peace of mind and strength to begin and complete this course. I am most grateful for all He has done for me. There are a number of people that I would like to acknowledge for their assistance and support to me. Perhaps, my profound gratitude goes to all and sundry who have assisted me in one way or the other in making this dissertation and, my Master‟s Degree in International Accounting and Finance a reality. Firstly, I wish to express sincere appreciation to my extremely inspiring, extraordinary and kind Supervisor, Enda Murphy, a Senior Lecturer at DBS for showing interest in this research work. His constructive criticisms, advice, suggestions, and understanding have been very encouraging. Enda, many thanks for all the assistance and support as I do appreciate it. Well Done-Maith Thu! May Almighty God bless you and yours-Amen! Moreover, I am also grateful to all my lecturers at the DBS for their valuable assistance and contribution to my course work especially James Brown and Andrew Quinn. Andrew, you made a remarkable difference to my academic life since I met you during my Diploma Program in Funding and Treasury. May Almighty God bless you and yours-Amen! Furthermore, I am also appreciative to all DBS Library Staff especially Sarah Kelly, Debora Zorzi and Colin O‟Keeffe who all provided me extraordinary and amazing assistance especially to my dissertation 3 Adeniyi Adekoya (10131831) project at the time of need and made a notable difference when completed- May Almighty God bless you all-Amen! Also, without mincing words, I am heavily indebted and grateful to a special person in my life - Kareemat Adesimisola, my lovely wife who sacrificed time, resources, and all what it takes to keep the home front and provided me moral and financial support in ensuring this program a success.- May Almighty God bless you-Amen! And of course, I am grateful to my lovely children – Michael, Mary, Mark and Melinda for their understanding and not posing any challenges to me during the program. May Almighty God bless you all-Amen! Finally, I express my sincere gratitude to my mother in America, Kunle Salami, Mr and Mrs Sowemimo, Mr and Mrs Onesirosan, Bukkie Sowemimo and Mr and Mrs Oriyomi Toyosi Adekoya for their moral, love and understanding. May Almighty God bless you all-Amen! Dedication May all the praises be to Almighty God, the one who make all things possible, where human beings thinks it is impossible. To my darling wife, Simisola, and the greatest gifts and sources of our happiness, Tomisin, Temitope, Timitayo and Titilopemi. 4 Adeniyi Adekoya (10131831) Abstract Derivatives contracts (DC) which have grown world-wide can effectively be used to reduce risk through hedging strategies. Many studies, both theoretical and empirical, address the important roles of derivatives markets in an economy and this study reveals that there are positive impacts on FNFIs to use DC to hedge risks and create liquidity efficiency income that is more effective and welfare-improving method to deal with price volatility. Nevertheless, it has been established that using derivatives contracts (for instance CDS) do have negative effects, although not in Ireland but in the US, which can lead to exacerbated volatility and seldom cause crisis (financial and economic) that could amplify the negative effects and accelerate contagion as experienced in Ireland in 2008.Thus, loss venture of this derivatives for the institutions concerned has to do with the problem of application, that is, the way in which the derivatives contracts has been used (i.e. wrong motive). Perhaps, the fundamental reasons for the derivatives negative effects on risk management are associated with the leverage nature of derivatives markets transactions, the non-quantification of risks, non-setting of risks limits, non-monitoring of both, lack of information and non-transparent reporting of transaction risks, non–evaluation of the soundness of the counter-party risks, unsophisticated or insufficient risk management controls in financial and non-financial institutions, as well as weak regulatory and supervision system termed ‗light touch regulation‘. Interestingly, academic literature clearly concludes that for countries derivatives markets to fulfil the functions of risk reduction, price discovery, hedging role, redistribution of income and stabilization compared to what has occurred in established markets, countries financial systems needs to be supported by sound macroeconomic fundamentals and updated financial policies and regulations. Likewise, scholarships have argued that while there is no uniform optimal development strategy, that countries can adapt to sequence or structure their derivatives markets; gradual development schemes accounting for dynamics in different markets should be encouraged. Additionally, for an optimal productive derivatives markets to reduce risk will require more fundamental reforms that will make it possible for market participants and regulators to determine and make judgement whether the risks faced by companies and institutions have been effectively been hedged with public information available from these markets in order to avoid speculation, volatility and the building up of risks in the system. Obviously, the quantification of risk, the setting up of risk limits and the monitoring of those risk limits will assist markets participants to manage their risk. Strikingly, other vital requirements to be initiated when using the derivatives markets are: the setting up of the counterparty risk limits in the derivatives markets transactions in order to assess whether counterparty may default, the market participant exposures, borrowing conditions of the counterparty, ability to repay back their debts, the counterparty appetite for risk-taking, the liquidity and solvency status and the establishment of more Central Counter-Parties Clearing House (CCPCH) as suggested by Charlie McCreevy's for the European CDS markets which he said will undoubtedly improve the operational efficiency of derivatives contracts markets to function fully in these highly interconnected global financial markets ensuring electronic trade execution, affirmation and confirmation indeed. Keywords: Financial and Non-Financial Institutions, Ireland, Derivatives Contracts, Hedging, Risk Management 5 Adeniyi Adekoya (10131831) Table of Contents Page Declaration…………………………………………………….. ..2 Acknowledgements…………………………………………….3 Dedication…………………………………………………………………...4 Abstract……………………………………………………………5 List of Tables and Figures……………………………………..6 Acronyms (Abbreviation) ……………………………………..13 Chapter One: Introduction 1.0 Introduction………………………………………………………………..14 1.1 Background Information and Overview………………………………..14 1.2 Research Problem………………………………………………………..24 1.3 Research Objectives……………………………………………………...26 1.4 Rationale and Justification of the topic………………………………...28 1.5 Research Questions……………………………………………………..30 1.6 Research Hypothesis…………………………………………………….33 1.7 Research Approach………………………………………………………36 1.8 Learning Style and Suitability of the Researcher……………………..37 1.9 Contribution and Recipients of the Study……………………………..40 1.10 The Scope and Limitations of the Research……………………….....41 1.11 Dissertation Organisation and Structure………………………………43 Chapter Two: Literature Review 2.0 Literature Review………………………………………………………….46 2.1 Literature Introduction…………………………………………………….47 2.2 Literature Review: Theme -1 (Financial and Non-Financial………….50 Institutions) 2.3 Literature Review: Theme 2 - (Risk Management)……….……………55 2.4 Literature Review: Theme 3 - (Derivatives Contracts)………………...56 6 Adeniyi Adekoya (10131831) 2.5 Literature Review: Theme 4 - (Hedging)…………………………………58 2.6 Contextualizing the Research in the Literature…………………………..62 2.7 Quantification / Measurement of Risk …………………………………….63 2.8 Setting of Risk Limits and the Monitoring of Quantification and Setting of Risk Limits…………………………………………………………....66 2.9 Learning‘s from 2008 Financial and Economic Crisis …………………69 2.10 The Impacts of the ‗New Capital Transparency and Adequacy - (Basel III) …………………………………………………………..71 2.11 The Role of Derivatives Markets…………………………………………74 2.11.1 Why derivatives are important in an economy?.................................78 2.11.2 What are the risks involved in Derivatives and why do we need to evaluate the soundness of counter party risk?........................................79 2.11.3 Example of Ryanair hedging strategies………………………………83 2.12 Literature Review Conclusion……………………………………………86
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