Investment Risk Management - Assignment Example

Investment Risk Management Based on the information you research related to Lehman Brothers, assess the factors that contributed to the financial failure of the firm, indicating how management failed to manage the risk related to each Factor. Make a recommendation for how firms should manage these types of risk in the future. Provide support for your recommendation. On 14th September 2008, 158 year old investment bank Lehman Brothers Holdings which was basically a global financial service provider became bankrupt, shaking the entire financial industry. There are various important factors which played a special role in causing such a huge financial failure to the firm. Poor mortgage related investment was a very major reason which caused this failure as the real estate portfolio of the company was in a very awful shape. The liabilities of the firm were more than the assets. The firms major sources of revenue was coming from government, corporate industry along with other giant clients to whom financial advice was given related to financial transactions along with acting as a underwriter to the clients. The leverage policy of the organization was a major reason why the bankruptcy took place which basically includes terrible regulations of the firm. Market satisfaction was another important factor was it made the firm too much confident about their financial policies along with lack of financial operation’s transparency. The mortgages were not priced correctly before lending them out .The credit default swap market also had a huge impact on the failure along with misrepresentation in the financial statements also acting as a key cause in the bankruptcy. High level of asset to equity ratio along with extreme high level short term debt financing basically caused major problems for the company. The company was so many dependants on the short term debt that it had to face the risk of runs. Systemic risk was faced by Lehman brothers. There were many recommendations given as to how the risk should have been controlled by many financial experts however for such risks which caused this financial catastrophe. The search for buyer should have been started way before it actually was, bailing out Lehman Brother could have been another beneficial step. Proper steps should have been taken to avoid capital inadequacy. The arrival of the crisis was expected however the auditors and management did not take proper steps to avoid it on time. It is important for the organizations to use new and better methods for checking company’s financial conditions and wrong accounting acts should be avoided by the firms. High-risk investments such as mortgage-backed securities, had a significant impact on the valuation of investments held with Lehman Brothers, yet many financial institutions continue to use these investments today. Assess the sufficiency of risk management techniques used by financial institutions today, indicating whether or not you believe the risk is appropriately managed to avoid a subsequent financial crisis. Provide support for your position. Lehman Brother financial failure was majorly due to high amount of investment being in the subprime mortgage backed securities. They lent millions of dollars in mortgage backed securities which were largely dependent on real estate prices however the downfall of real estate played a major role here. Lehman Brother invested largely in commercial paper thus their assets s were the loans given out were less, where as their liabilities were more , even increasing with every passing day. The risk associated with the property price here is important which was neglected and the downfall was not predicted which shows negligence from the management side. There are various models which are used by many credit agencies, regulators and bankers for managing the risk.It are important to keep in view the behaviors of the institutions along with the financial products and the firms. In order to manage such risks there should be proper written procedures and policies which should be analyzed and kept in view before entertaining credit requests. The kinds of loans to be given or not should be clearly mentioned in the policies. The detailed documentations should be analyzed along with keeping in view the market risk and the credit risk. The lenders and firms should properly evaluate the collateral along with checking the lines of authorities and also the techniques which are used and evaluated for pricing. Evaluate management’s role within a financial investment firm for establishing proper risk management procedures for high-risk investments and the appropriate level of accountability for portfolio performance. Determine the consequences that should be enacted when Financial Firm Management fails to perform their fiduciary obligation to investors, indicating how these consequences should be implemented. Provide support for your response. Management plays a vital role in financial investments, and in managing risk. Management needs to consider multiple factors before investments can be made or before loans can be given out which basically are the assets or the investments for a bank or a financial company. Borrowing purpose and honesty should be properly evaluated along with checking the legal authority of the borrower regarding signing of the loan agreement. The portfolio performance, the investments of the bank should be properly and honestly audited without any false misinterpretation by the management so that an honest condition of the company should be visible for the investors. Management should add and increase transparency. It is important to keep in view the fiduciary obligations to investors before determining the consequences. The duties include utmost care which means that means proper protection. Integrity is crucial along with proper disclosure. Loyalty is also important along with proper legal liability being on the investment company. The broker should make sure that the financial position of the customer is properly evaluated to see if the risk can be taken or not. If the financial firm is into excessive trading, that also counts as a hurdle along with setup of short term trading. Given the recent debt crisis within the EURO zone of Europe, analyze the impact to the performance of foreign markets and recommend a strategy for financial firms to minimize investment risk in these markets. Provide support for your recommendation. The strategies which are developed by the firms should be such which should help in reducing the investment risk. The most important method here is diversification, where the asset should be invested in a portfolio of investment from stocks, bond and other investments because at the end of the day at least one financial market will be performing well. In bonds investments the maturity period should be laddered out which can also help the companies in reducing the investment risk in the markets. Usage of derivatives like option also helps in reduction of investment risk. There are various financial risk components which play an important role in foreign markets performance from exchange rates along with percentage of export and also import. Foreign debt with respect to the GDP also plays a vital role in the performance being evaluated and the impact on the foreign market. Evaluate the role of the Federal government, if any, related to the regulation of investments by financial institutions including the scope of the role, the authority and enforcement capability within the regulatory agency, the benefits, and consequences of regulation. Predict how the regulatory environment may change over the next five (5) years. Provide support for your prediction. Federal government plays a very important role when the regulations are made regarding the investments which are done by the financial institutions. The Lehman Brother crisis was majorly caused by the failed regulations along with deregulations along with over regulations who wanted to increase ownership of the houses which caused extreme problems. Government regulations aim was to increase the pressure on private banks regarding the loans which were risky. Regulatory environment is predicted to change over the next five years as more skilled finance people are coming in. Also the need and requirement of corporate governance along with proper high level investor relations is increasing which is making the regulations to be developed accordingly. The regulatory development is expected to change in coming 5 years as the investment companies are spending more time and finds in financing talented people who can help in improving investments and methods of making the investment process healthy. The reporting system is improving which thus helps in adding an additional value to the business. The regulations will be more focused on increasing efficiency and reducing legal, capital and operational risk of the investment companies. BIBLIOGRAPHY Chapman, P. (2012). The last of the imperious rich: Lehman Brothers, 1844-2008. London: Portfolio/Penguin. Chong, Y. Y. (2004). Investment risk management. Chichester, West Sussex, Eng: John Wiley & Sons. Tibman, J. (2009). The murder of Lehman Brothers: An insider's look at the global meltdown. New York: Brick Tower Press. United States. (2010). Public policy issues raised by the report of the Lehman bankruptcy examiner: Hearing before the Committee on Financial Services, U.S. House of Representatives, One Hundred Eleventh Congress, second session, April 20, 2010. Washington: U.S. G.P.O. Walker, G. E., & Clarke, L. D. (2012). The Lehman Brothers bankruptcy: Analyses. New York: Nova Science Publishers. Read More