How can an multinational private equity and alternative asset management company

Question

How can an multinational private equity and alternative asset management company like The Blackstone Group hedge the following risks to limit their loses in adverse cases?

1. Market Risk: Market risk can occur due to substantial changes in the general market (that the company is operating in), or changes in the entire economy as a whole.

2. Interest Rate Risk: Interest rate risk occurs when market interest rates fluctuate and affect the returns on company's assets or their long term debt.

3. Liquidity Risk: Liquidity risk refers to company's ability to meet their short term financial obligations in normal conditions and in distressed economy where everyone is looking to cash in their investments.

4. Credit Risk: Credit risk refers to the fact that the loan borrowers may default on their obligations.

5. Operational Risk: Managers not fulfilling their duties or not utilizing the companies capital efficiently, causing major losses.

6. Currency Risk: This type of risk refers to fluctuations in foreign exchange market. A company like The Blackstone group is exposed to this risk because it invests in many countries outside the United States.

7. Geopolitical Risk: Geopolitical risk can occur when the relationship between countries is affected by the geography and economics between the countries and it results in major losses for companies like Blackstone group because they may have investments in both affected countries.

Please explain briefly what strategies can The Blackstone Group use to hedge all of these risks so that when an adverse condition arises, The Blackstone Group has limited losses.

Thankyou

Explanation / Answer

The Blackstone Group can use the following strategies to hedge their risk:

Market Risk: Blackstone group can buy put options on the overall market. Put options work as insurance and provide protection on the downside. If the market moves downside then losses in the portfolio will be offset by gains in the put option.

Interest Rate Risk: Since long term assets are yielding a fixed rate of interest then any upside movement in interest rates will lead to fall in the value of assets. Therefore, Blackstone Group can change their fixed rate interest rate yielding assets to floating by entering into an interest rate swap. In the interest rate swap Blackstone can be the fixed rate payer, and a floating rate receiver. So the fixed rate from assets and fixed rate from the swap will cancel out thereby leaving Black Stone with a floating rate asset.

Liquidity Risk: Blackstone Group can hedge against liquidity risk by securing loan commitments and lines of credit. Loan commitment is a promise from lender that a specified amount of loan or credit will be available at specified rate of interest for specified period of time. Line of credit is the maximum amount that a borrower can borrow at any time as long as he/she makes timely payment.

Credit Risk: Blackstone Group can hedge against credit risk from counterparty by buying Credit Default Swaps (CDS). CDS are insurance contract that provide payouts in case the counterparty defaults. In order to buy insurance Blackstone will need to pay premium to CDS seller.

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