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In recent years, managers have become aware of how their companies can be buffeted by risks beyond their control. To insulate themselves from such risks, many companies are turning to the derivatives markets, taking advantage of instruments like forwards, futures, options, and swaps. Although heavily involved in risk management, most companies do not have clear goals underlying their hedging programs. Without such goals, using derivatives can be dangerous. The authors present a framework to guide top-level managers in developing a coherent risk-management strategy. That strategy cannot be delegated to the corporate treasurer--let alone to a hotshot financial engineer. Ultimately, a company's risk-management strategy needs to be integrated with its overall corporate strategy. A risk-management program should have one overarching goal: to ensure that a company has the cash available to make value-enhancing investments.

Colt Industries is a conglomerate that is considering undertaking a leveraged recapitalization. The deal would involve a large one-time dividend to stockholders, which would be financed by over $1 billion in new debt. Unlike in an leveraged buyout, however, public shareholders would still retain an equity interest in the company. Shareholders in the company's employee savings plan would not receive the dividend, but instead would see their percentage ownership in the company substantially increased.

Spreadsheet Supplement for case 289012.