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Use of Derivatives in Risk Management - Term Paper Example
Author : gerholdbrenda
Finance & Accounting
Pages 7 (1757 words)
Financial Risk Management
Risk is a legitimate part of business activity because of the globalized volume of corporate structure. Multinationals are working in various foreign countries due to saturation of the local markets…
Following are the major sorts of instruments applied by organizations to manage the financial risks associated with business activity. Futures and Options In this type of instrument, one individual or business signs a contract with another one to purchase the commodity on some future date with an agreed-upon price. However, in futures both of the parties have to go through with the contract while in options both of the parties reserve the right to withdraw the contract upon paying in monetary terms.
Agreements: This instrument is localized in nature, and governments do not interfere with its transactions. Nevertheless, the purpose of these agreements is the same as that of futures and options, which is to hedge against fluctuations in the market price of the commodity or an industrial product. It is also important to note that these kinds of agreements are more common in economically distressed nations. But, recently they are intensively deployed in order to ensure a supply of raw material in US, which is necessary because of the prevailing recession in the local market.
So, it is safe to assume that businesses are preparing themselves for increasing adversities of the future by contracting with their suppliers on a long term basis, which also enables them to attain economies of scale as a result, driving their financial and operational costs down that allows them to lower their prices in order to increase their market share. ...