Financial Risk Management Essay Sample
Thepurposeof this survey is-
To happen out whether investors receive equal information sing the hazard faced by the entity. to enable them measure a company’s public presentation non merely on return but besides on the hazard assumed in order to bring forth the returns
Theaimsof this survey are-
Adams Wood. in his book Foreign Exchange Risk. defines fiscal hazard direction as pull offing the uncertainnesss environing possible investings. A undertaking or an investing is considered hazardous if there is uncertainness sing the realisation of expected hard currency flows. Fiscal directors and investors keep contriving new ways of raising money and avoiding hazards. Changes in involvement rates can do borrowing money really expensive and really dearly-won. Corporate fiscal directors. every bit good as investors need to do certain that possible economic fluctuations do non endanger the house or their concerns. Smart investings and funding determinations are important to a houses and an individual’s success. For smart investings to be undertaken. investors and persons should be to the full cognizant of the hazards environing their investings and possible returns that would be generated from their investings.
Many companies prefer to supply minimum information to investors sing the hazard faced by their companies. They normally prefer to maintain it under screen since they know that many investors prefer taking really minimal hazards at the same clip anticipating high returns. which in most instances. is non the instance. since companies that generate more grosss are those that are willing to take high hazards. This has led to what is known as ‘Agency Problem’ . which refers to the struggle of involvement between companies and their stockholders or investors. Most companies hence leave investors to detect on their ain the hazards they face. These has affected most investors. since they put their money in companies without all the relevant information on the degree of hazards they are being exposed to. go forthing them with the premise that their investings will ever make good and that they will acquire high returns which is seldom the instance.
Among the companies that filled the questionnaires. there were some companies. which provided sugar coated information ( e. g. originative accounting ) . These companies would do certain that they systematically get good returns but did non pass on to investors the degree of high hazards that they exposed their investings to. These companies withheld information. since they feared losing investors. who were the major subscribers to the capital base of the company.
There should nevertheless be the realisation that. every peculiar investing has some degree of hazard inherent in it. Hazard and Return are closely correlated. Companies and persons can non avoid hazard. because by its really nature. concern and investings involve taking hazards. in order to work the available profitable chances. However. the company should non take unneeded hazards. neither should they take hazards that are out of character and which the stockholders do non anticipate.
High hazardous investings normally have higher returns than low hazardous investings. In add-on. investors vary. from those who are willing to take high hazards. to those who are willing to take minimum hazards. M. Rees. in his article. ‘What type of investor are you? ’ classified investors into three classs. every bit far as hazard is concerned. They included-
They are those investors who admire hazards and will set about a given investing if it promises a higher return irrespective of its hazard degree.
They are those investors who do non look up to hazard and will prefer undertakings with a lower hazard degree.
Before investors receive any equal information about their investings. they should be to the full cognizant of the degree of hazard they are willing to take. On the other manus. all companies have the duty to supply the relevant information that may impact the stockholders investings. Companies are required to supply prospectus to new investors. be aftering to shoot their financess in the company. A prospectus may be defined as a legal papers prepared to depict what the concern or company will make. every bit good as who the managers of the corporation and its major investors will be. An investor will be able to cognize whether the vision. mission and the ends of the company relates or reflects with his ain.
Company’s Acts. Government Regulations. and capital market regulators have besides made it a demand for all listed companies to do revelations of their fiscal statements to investors and the populace. This capable companies to scrutiny from members of the populace. hence heightening transparence of company’s activities. There has besides been a greater accent in recent times. of an bureau relationship between corporations and their investors every bit good as a greater run on companies to prosecute themselves in corporate administration activities. This is expected to cut down struggle of involvement among companies and investors.
Corporations should accurately show the hazard factors to investors. This would assist investors make up one’s mind where to put and find the hazards they are willing to accept. It would besides assist investors make estimations of Returns on Investment ( ROI ) .
Corporations and investors may utilize statistical methods to accurately step hazard. They may find the Expected Monetary Value ( EMV ) . the Standard Deviation and the coefficient of fluctuation of their investings or undertakings. The expected pecuniary value is an norm of all expected hereafter hard currency flows of any given undertaking. Standard Deviation is a step of the stringency of the chance distribution.
When pull offing hazards. it is advisable for investors to unite assorted investings. in order to cut down their hazard on investings.
Stockholders investings are normally capable to assorted hazards. They include political hazards. cultural hazards. exchange rate hazards. legal hazards. technological hazards. market hazards. and fiscal hazards. In my thesis. I will concentrate on involvement hazard and currency hazard.
Foreign exchange hazard arises due to the demand to cover with more than one currency and consequences from possible alterations in the values of these currencies relative to each other. The exchange rate is the monetary value of one currency in footings of another currency. The foreign exchange hazard is present whenever a companies assets are denominated in the currency of its ain currency and it operates in the foreign currency. There exist three major types of exchange rate hazard.
Companies are required to turn to the hazards of involvement rates and foreign exchange rate. They may use assorted methods of pull offing hazards. so that investor’s returns become safe. The schemes they employ include.
The most common and operable methods that companies and investors ought to utilize to mange currency hazards and involvement rate hazard include-
An option is the right to purchase ( name option ) or to sell ( set option ) the implicit in plus at a specific monetary value ( exercise monetary value ) within a specified period ( exercise period ) . Option contracts as a method of hazard direction are zero sum games. because the additions to one party is equal to the losingss of the other party.
It arises when a purchaser has a right but non an duty to buy the implicit in security at a specific monetary value in future. Since he has a right but no duty. he will usually near the marketer to buy the implicit in security when conditions are favourable to him but unfavourable to the marketer. The purchaser is usually required to pay a commitment fee known as premium.
It gives the marketer the right to sell his security at an in agreement monetary value ( exercise monetary value ) within a specified period. Normally. the marketer will exert the put option when conditions are favourable to him but unfavourable to the purchaser. For this ground. the marketer will be required to pay a committedness fee to the purchaser.
2. Use of barters
This refers to a common understanding to interchange the duties underlying a given dealing. The major purpose of swapping is to fudge against the bing hazard by reassigning the current duty to a new duty. There are usually 2 types of barters: –
The purpose of this barter is to alter the duty from a state of affairs where payment is made in one signifier. to a state of affairs where payment is made in the foreign currency. For illustration. Assume that there are two companies. one is a UK company wishing to borrow Kenyan shillings. to finance an investing undertaking in Kenya. If the UK Company is non known in the Kenyan Market. it will hold to pay higher involvement rates than the Kenyan companies pay on the Kenyan money market. To set up a barter the American company will hold to place a Kenyan Company confronting similar jobs of borrowing the UK lb. The two companies will therefore arrange the undermentioned barter. Even though the usage of barters is a good hazard direction tool. there are some hazards normally associated with it. They include recognition hazard. Market hazard. Sovereign hazard and Mismatch hazard.
This refers to a fiscal understanding between two parties with respect to exchange of hard currency flows related to a specific implicit in duty. The cardinal aim is to change over the loan. which is in the signifier of a fluctuating involvement rate into a loan. which is in the signifier of a fixed involvement rate. In involvement rate barter. one company may be interested in fudging against the fluctuations in involvement rates while another company may be interested in guess.
It involves making a liability if there is an plus receivable or making an plus if there is a liability to be paid. For illustration. if the company is to have some money and its major concern is to fudge against the grasp of the local currency. so the company can borrow abroad therefore making a liability. In this instance. the decrease in the value of the sum receivable ( plus ) will be compensated by the decrease in value of the sum collectible and vice-versa. In this instance. a loss through a liability bing or created is compensated by the addition through an plus existing or created.
4. Leading and Laging
This involves fixing or detaining payment or reception of money as a manner of seeking to cut down hazard.
In taking. the exporter fastens the reception of the sum due if he anticipates the local currency will appreciate. On the other manus. an importer will besides fix the payment if he anticipates the local currency is traveling to deprecate.
Laging leads to the hold of payment. For illustration. the exporter will detain the grosss. if he anticipates the depreciation of the local currency. while an importer will detain payment if he anticipates grasp in the local currency.
5. Money Market Hedging
It refers to borrowing abroad or puting abroad. so that the cumulative sum will help in paying the sum due for an importer or the cumulative sum will help in fudging against the inauspicious motion in the exchange rate.
Borrowing applies to an exporter. in the instance where the exporter can borrow abroad and put locally. He will so utilize the cumulative sum receivable to pay the sum due. In this manner. the exporter will be able to pull off the inauspicious motion in the exchange rate.
They are promises to purchase or sell something in the hereafter. at a given monetary value that is agreed upon. They are trade on organized hereafter exchanges.
They are similar to hereafters. but they are arranged straight between a house and a bank.
Firms and persons may utilize derived functions to cut down hazard. every bit good. as speculate through purchasing and merchandising of derived functions in the hope of gaining net incomes. When these guesss do non work out. losingss can be significant ; hence. investors should take great attention when covering with them. For illustration. the UK Barings. one of the world’s oldest Bankss. collapsed in 1995 due to hereafters guess by one of its bargainers.
Harmonizing to John Smith. in his book ‘Summary of Risk Management Models. ’ he concludes that. there is no 1 individual method that confidently res confirm its capableness of wholly fudging hazard. It is hence upon the company and investors to take the hazard direction theoretical account that would outdo cut down their exposure to any given hazard.
In decision. corporations are expected to unwrap all their activities to investors. so that investors may measure the hazards before puting. Investors should so compare the hazards and the returns. and find whether. it would be feasible to put in that peculiar undertaking.