In relation to a convertible arbitrage trade in general, carefully explain what is meant by the convertible bond's two convexities and how these convexities affect the hedging choices of the portfolio manager.

What is the main purpose of a hedging strategy using a forward contract or a futures contract? Explain very briefly.

How are derivatives valued on the balance sheet? How is the adjustment to fair value recorded differently for a cash flow hedge versus a fair value hedge? That is, how does the fair value adjustment of each type of hedge affect current period net income and the accounting equation? What are the three criteria that must be met for a derivative to be classified as a hedge?   Once entities decide to buy or sell derivatives to hedge economic risks, they then need to decide whether they want to use hedge accounting; it is an election, not a requirement, even when the derivatives are for the economic purpose of hedging. This election is reminiscent of inventory accounting. Just like when a company selects an inventory method, a company is not required to select the accounting method (LIFO, FIFO, weighted average, specific unit) that most closely corresponds with the physical movement of inventory, although they are free to do so. If entities decide to elect hedge accounting, the following…

a)define interest rate swaptions, and differentiate between payer swaptions and receiver swaptions.    b)define forward swaps.     c)define risk management.    d)discuss reasons for practicing risk management.    e)discuss how firms can benefit from risk management.