Financial Market Program: Trading Strategies and Risk Analysis

This project analyzes trading strategies within a financial market program, focusing on risk management and hedging techniques for Eco Friendly Power Pty Ltd. It explores the implementation of trading strategies, market analysis, and the selection of appropriate hedging instruments like interest rate swaps and caps. The project examines the use of quantitative and qualitative data, including market forecasts and volatility assessments, to inform trading decisions. It delves into the application of trend trading and swing trading strategies, the use of caps versus swaps for hedging, and the importance of monitoring and reviewing trade positions. The project also covers the analysis of swap transactions, including the financial data required for effective analysis and the impact of market data releases on trading positions.

Running head: FINANCIAL MARKET PROGRAM
Preparing Trading Strategies
Name of the Student:
Name of the University:
Author’s Note:

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Table of Contents
Question 1........................................................................................................................................2
Question 2........................................................................................................................................4
Question 3........................................................................................................................................8
Question 4......................................................................................................................................10
Question 5......................................................................................................................................12
References......................................................................................................................................14

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Question 1
a) Implementing a trading strategy in order to implement the financial goals of the company
is one of the key principle and aim behind having a effective trading plan. Trading
strategies are implemented by companies in order to curb down or reduce the market
exposure with which the investment of a company is associated with. The implemented
trading strategy should be aiming at creating a effective and a sustainable set of return for
the company (Usbank.com 2019). Eco Friendly Power Pty Ltd should be creating the
effective trading strategy for the business operations of the company after taking the
macro-economic view and the business factors under which the company operates. The
key information that would be required from the perspective of the company should be in
the form of various needs and objectives of the company as follows:
 Forming Up the Market Ideology
 Select a Market for the Purpose of creating a trading strategy
 Selecting the time frame of trading period.
 Selecting a tool for the purpose of determining the trend.
 Defining the Entry Trigger of the company i.e., selecting the right time to enter
into the desired trading strategy.
 Making and Planning the Exit Trigger of the company.
 Defining the level of risks that would be undertaken by Eco Friendly.
 The planned trading rules for the company should be well consistent and must be
worked with a back test analysis.
 Continuation and Learnings from the trading strategy developed.

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b) The business operation of Eco Friendly Power Pty Ltd is primarily exposed with the
changing business conditions and the changing market conditions of the various types of
commodity and assets value that would be significantly affecting the overall return
associated (The Balance, 2019). The energy prices, commodity prices and the fair value
of several assets can significantly affect the net worth and the fair value of the assets.
c) i) The outline of the fundamental market can be well done with the analysis and the
outlook for the electricity swap market for the next three years. During the analysis of the
electricity prices it was well found out that the electricity prices were forecasted to fall by
around 2.1% in the two years due to wind and solar energy. Lower amount of wholesale
price in the market would be giving the typical households an all-around savings of $55
in an annual year for the next two year of time frame. The increase in the wind and solar
generation would be helping drive down the power prices by around 2.1% on an average
for the next two years (Hudson 2017). If the prices of the commodity or product is
expected to fall in real terms, then in the same period the value or the prices of the
expected spot rate is expected to fall in the near terms. The company is expected to enter
into a short forward contract where the forward curve is expected to show a steep
downward movement.
ii) The qualitative data that would be taken into consideration would be the non-
numerical characters and approximates regarding the data represented by the Australian
Energy Commission (Bacha 2017). On the other quantitative data in the form of
percentage analysis reflecting the fall in the prices of the commodity and other energy
prices.

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iii) Both the quantitative and qualitative data were taken into consideration for the
purpose of planning out the analysis and the changes that is expected in the price level of
commodities and various other products that is associated with the company.
d) As identified with the data collected below that the expected price of the energy prices,
commodities is expected to fall by around 2% which signifies a significant fall in the
overall value and the key trading strategies that can be better applied could be as follows:
 Trend Trading is an outstanding way of earning profits without spending a
significant time analyzing the data. The trend can be well analyzed by the
company where it should enter into the trade now and hold their positions until
the trend reverses. The key risk in this type of trading strategy would be defining
the correct entry and exit point of time (Gupta 2017).
 Swing Trading can be one of the best option whereby the company can utilize for
the purpose of capturing gains in the stock or any defined financial instruments
over a period of few times. The trading strategy can used by the company for
capturing the trading opportunities available. The key risks could be in the form
of reverse trend that is expected by the company.
e) There are various information’s and data that are captured by an organizations for the
purpose of creating an effective trading strategy for the company. The key trading
strategy related information that can be better used by company would be getting relevant
data bout the market and the associated business risk that would be affecting the
operations of the company. The trading time period or the time horizon and the
associated trading risk that the company would be requiring for the purpose of hedging
(Kahalé 2017).

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Question 2
a) Interest Rate Swaps and Caps can be an effective tool for the purpose of hedging interest
rate risks. It is important in order to use the above tools effectively that the borrower
needs trustworthy advice for the purpose of selecting the right hedging tool and to
negotiate attractive terms and competitive pricing. The key reason for selecting caps over
swaps is mainly due to the time frame of the portfolio investment under which the
portfolio is exposed with (Rebentrost, Gupt and Bromley 2018). The portfolio is currently
having a net short position in the both peak and off peak period because the fall in prices
of the energy prices would be affecting the overall value of energy prices to the company.
However, as estimated that in the near term future where the sport volatility is set to
increase for a period of three month of time frame. Caps are the best hedging instruments
when considered for a shorter period of time on the other hand, swaps would be the best
option for hedging when the trading period taken into consideration is for a sum of a
longer and continuous period of time for hedging (LiPuma 2017).
b) In the given scenario where the spot prices is expected to increase and the company’s
portfolio is already having a short position whereby any fall in the prices of the
commodities would be offset by the derivative instrument done by the company. If the
sport prices is expected to rise along with the increase in the volatility then the call option
or the caps would be the best option where it would going on long in the cap transactions.
If the spot prices of the commodity as expected increases for a shorter period of time then
the long cap which would be done by the company would be benefiting the company in
hedging the net position of the company (Tvedt 2019).

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c) In order to enter the deal for cap transaction the company first of all needs to identify the
amount or value of commodity prices it needs to hedge. The time period which would be
taken by Eco Friendly Company would be around three month time. The company would
be going long in the cap transaction by buying call options or a series of call options
which is called an cap for the underlying assets in needs to hedge i.e., energy products. In
the case of cap transactions only a nominal amount would be paid while entering into the
call option (Abdel-Khalik and Chen 2015). On the other hand in the case of swaps the
company would not be paying up any notional amount of money, it would only be paying
up the difference between the agreed fixed and floating rate.
d) It is important to note that after entering into the cap transaction the company did went
long on the cap transactions whereby as expected that the sport prices are expected to rise
and the associated volatility is set out to increase. These key factors outlined would be
increasing the overall spot value of the energy prices and the portfolio of the Eco
Friendly Power Pty Ltd states that it is currently short on the portfolio. However, after
taking into account the expectations regarding the spot price volatility which is expected
to increase and so does the expected spot price that can materially affect the hedge
position already entered by the company (Brogaard, Dimitrova and Eswar 2018). After
entering into the cap option the company has actually reduced or offset the loss that
actually would have incurred by the company due to the net rise in the spot prices. As
observed in the below table given that Net Short Long Position of the company has
remained sustainable for the company after entering into the cap transactions by hedging
the unexpected losses that materially would have affected the overall value to the
company. The net value or the position of the company has remained sustainable.

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e) As observed in the below table given that Net Short Long Position of the company has
remained sustainable for the company after entering into the cap transactions by hedging
the unexpected losses that materially would have affected the overall value to the
company. The net value or the position of the company has remained sustainable.
f) The market data released were in well line with the expected volatility and predicted fall
in the prices of the energy and commodities with which the Eco Friendly Power Pty Ltd
is associated with. The company was previously having a net short position on the
commodity and energy prices however with the change in the outlook and perspective
that spot price I expected to fall they entered into a long cap position. There would not be
much impact on the Jim’s net position as the news were in well line with anticipated
action taken. However, on the other hand the time period with which the company
expectation and as per the market data so it is important that the company consider the
same and takes the change in trend period for hedging into account. Since, the company
is having a existing a net short position on the portfolio and after buying the three month

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cap it should consider buying the six-month cap for the purpose of completely hedging
the long short position associated with the company (Huan and Parbonetti 2019).
g) Monitoring and reviewing the trade positions of the company is an important factor and
the companies should analyzed and interpret the trade information in an effective manner
so that it is able to capture the results that is associated or generated from the trading.
Mark to market is also such kind of financial trading report that is presented to the
company containing the changes in the fair values of the underlying assets and the
resultant value of the derivatives position in which it is exposed to. Mark to Market report
.also let the company know or analyze the amount it has generated from the derivative
assets and the amount it owes due to the change in the value of derivative position.
Question 3
a) In order to analyze the swap transaction there are various financial data that would be
required for the purpose of analysis. The financial data can be in the form of value of
contract the fixed rate which is one part of the swap and the floating leg representing the
other side of the swap transaction done by the company (Xia, Kee and Lee 2018). The
value of contract which is also called the notional amount in swap is also an important
part that would be taken into consideration for the purpose of determining the value on
which changes in net position would be paid. Terms and settlement of contracts are also
some of the crucial points that needs to be gather for the purpose of analyzing the swap
transactions.
b) It is important that when entering into a swap, the fixed rate would be equal to the
floating rate payment, that otherwise would be calculated from the agreed counter value.
Swaps are typically quoted in a swap spread that would be calculating the difference

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between the swap rate and the counter-party rate. On the other hand the value of the
swap for a party would be calculated by the difference between the fixed and floating rate
of interest or prices that is agreed between the two parties and the percentage change
would be taken into consideration for the purpose of multiplying the value with notional
amount in order to get the value to each party. On each quarter the value of the swap for
each party would be calculated by the above method described.
c) Calculating the Flat NSW Swap price for Cal 18.
Period Peak ($/MWH) Off-Peak
Q1 18 $115.50 $77.50
Q2 18 103.5 84.35
Q3 18 91.3 76.25
Q4 18 83.6 66.2
Total Value $31.90 $11.30
d) It is well important to consider various factors and conditions that are directly associated
with the trading. The entry time for the company should be consistent and in a timely
manner when they expect any changes in the underlying asset or spot prices, the exit time
for the company should be considered when the target or the expected volatility
associated with the underlying asset is expected to stabilize (Martin 2018). The company
should well define their entry and exit point of time in order to get the effective trading
results. On the other hand it should well place it trading limit that actually would help the
company manage the risk associated with changes in the prices of the underlying asset or
spot prices. Monitoring the swap position of the company is also an important factor that
should be undertaken as if things go wrong for the company then the company could take
certain necessary action in order to curb or reduce the same in the due course of time
period (Hutzenthaler, Jentzen and von Wurstemberger 2019).

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Question 4
a) Derivative Trading involves changes in market factors and the associated changes in the
underlying asset of an commodity or asset which result in the change in the value off
derivative position. The key risks that the company would be facing would be primarily
in the field of market risk that can significantly affect the net short or long position of the
company. Changes in the macro economic conditions and the associated factors that is
closely tied with the underlying assets are the key approaches that the companies are
exposed when trading a cap (Major 2018).
b) In order to better measure, manage and limit the associated risk exposure the following
should be applied by the company.
 Market Based Risks: The key market based risk that is associated with the
company whereby the company can experience loss sue to some factors that
would be affecting the overall performance of the financial markets. The market
based risks can also be mitigated by the company in the form of diversification by
investing into various commodities.
 Credit Based Risk: It should be well captured by company by analyzing the daily
mark to market position of the company and the net traded value of transactions
done. The credit risk that the company can face is the counterparty risks that the
company can face when going for a swap transaction or a forward contract where
the counterparty can default (Chang and McAleer 2015).
 Trade Processing Risk: Proper Analysis of the daily trade sheet done and
checking the same with trade copy generated by brokers.

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c) Review and Analysis of Risks should be solely done based on the various classes of risks
that can potentially affect the company. The market based risks can be managed with
help of examining the key market factors that is affecting the volatility or the price
change. Credit Risks can be well countered by the company whereby each party deposits
an nominal set of amount with an depositor or exchange (Devi and Efendi 2018). Trade
Processing or Operational Risks can be well managed with the help of cross-checking of
the deals traded and as well as executed from the broker’s side.
d) It is well important to understand the market and operational risks that are well associated
with the trades and transactions that are usually carried out by companies. If a trading
limit is breached then it is well important that the company unwinds its position in the
underlying asset after analyzing the impact and the limit or the excess amount with which
the company is exposed with.
e) Impact of following factors on Trade:
 Interest Rates, Exchange Rate and Inflation: If the interest rate or the inflation
level increases in the economy then the same would be affecting the borrowing
level and the associated borrowing costs. On the other hand volatility in the
exchange rate could be significantly affecting the trade position.
 Economy and Business Cycle: If the economy under which the company
operates is under a recession period and the company goes long on specific
underlying asset that is highly correlated with performance of economy then the
same would be affecting the trade position (Lyuu et al., 2019).