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Corporate Risk Management - Assignment Example

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Name: University: Tutor: Course: Date: Corporate Risk Management Financial risk management is a very sensitive issue for many firms in a modern market environment. While insurance is the de facto method of hedging financial risk in business, it can be very costly and this requires the business to have alternatives to hedge its financial risk (Frank, 89)…
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Corporate Risk Management
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Corporate Risk Management

Derivatives Derivatives refer to a method where one party owning a risk transfers the risk to another individual (Malz 189). The party receiving the risk bears the risk but at the same time has the advantage of making a profit is the risk does not materialise. The original owner of the risk does not have to pay anything to the risk buyer but has to forego any benefits derived from the non-occurrence of the risk. The advantage of this method of risk management to the business over using insurance is that the business is not obliged to pay any insurance premiums and therefore the only cost is the opportunity cost which the business has to bear due to not being able to benefit when the risk does not occur (Deventer & Imai, 48). The market for derivatives has grown significantly for some time, perhaps because of the increasing risks in the global business environment. Globalisation and technology have brought numerous opportunities to the business environment but at the same time brought numerous risks to businesses around the worlds (Norman, 58). As several risks have increased and their intensity in terms of likelihood and impact has increased, the need to have better ways to manage the risks has also increased. In such an environment, derivatives made from financial risks have increased and there are firms which are dedicated to trading on derivatives. Derivatives come on all sorts of nature, depending on the nature of risk (Triantis, 563). Forwards Forwards are a very good tool for managing some types of financial risks. These are risks associated with unexpected unfavourable changes in the market environment in the future (Darrell, 78). For instance, a firm may be concerned that the rate of exchange will change unfavourably in the future and thus affect its revenues. This usually happens with regard to firms which operate across international borders. In this kind of scenario, the firm can choose to have a forward contract with its customers or suppliers (Verzuh, 59). Forward contracts help the business in guaranteeing that its revenues or its business will not be affected in the future by making sure that the natural laws of the market will not come into action. For instance, in the example given above, a firm may have a forward contract which binds its suppliers to deliver the goods at a predetermined dollar rate regardless of the currency exchange rates in the future. This means that such a firm will operate without worrying that unexpected foreign exchange rates will affect its revenues in a negative way. Decentralising the business functions As identified above, currency risk is one of biggest risk which international businesses have to face today. In a modern business environment, even a slight change in the currency exchange rates can lead to massive losses for firms which manufacture their products locally and sell them abroad (Gregory 57). In this regard, apart from forward contracts, there are other options which such firms can consider in order to eliminate currency risks. These include the decentralisation of business to other countries especially where the business has the biggest markets. This has been demonstrated by the recent trend of American manufacturers going to china to set their manufacturing firms there. One of the firms which have been known to have been the first one to use this strategy of ... Read More
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