Financial Risk Management Essay

INTRODUCTION:
Hedging, by Acharya et al.(2009) is described as a manner of reducing and eliminating the level of exposure to risks inherent in commodities, foreign currencies and financial assets. It would aim to minimize or dampen the effect of prices and rates volatility on a firm’s profit, generated by currency or financial risk. Big size companies are usually the ones to seek for exposure management, as trading worldwide place them directly in contact with unpredictable change in capital market, currency rate and translation rate. Therefore they would use derivatives as an attempt to decrease the risk deriving from such variability. Many studies made over the past years, debated on whether hedging exposure is an adding value for company, when they succeed in reducing the cash flow’s volatility, or would have little or no effect on the firm appraisal. In other words, by controlling a speculative bankruptcy costs, would the return arising be greater than the costs allocated and worth the risks taken? When we know that capital market move randomly with high uncertainty. Can an imperfect capital market produce positive advantage (adding value), to organization willing to hedge their exposure to hazard and unstable market prices (currency prices, interest rates, foreign currency). Would the capital market’s variability truly provide a possibility, to firm to use that unsteadiness to make gains? By using for example hedging contracts such as currency contract, forward or option contract. Searchers are still septic with the probability of such outcome. Therefore, we will discuss on hedges exposure issues based on relevant and previous research.

RISK MANAGEMENT APPRAISAL:
Understanding the benefit, or probably, the no-profit economic value of hedging exposure is to realise that, the financial key of every businesses lies on its cash flows; consequently, how well an organisation is apt to handle its cash flow would usually determine its time length on the market field. Generally, trading would

expose businesses to capital market variation such as exchange rate, price fluctuations, economies of scale, tax, which would have a major impact on the
Company profitability and as a result on the cash flow. Then, trying to control the volatility of the cash flow is a considerable commitment for management, because doing so would help them to minimize financial distress cost, control underinvestment problem and reduce expected tax payment. An underinvestment problem would arise when shareholders have a little claim of company’s assets (Bartram, Brown, & Fehle 2009), due to that they would only be willing to take up small projects with less risk, which usually can generate a conflict of interest between shareholders and management . Moreover, the shareholders’ aversion to have their dividend payout cut down, making managers unable to accumulate internal funds ( retained earnings) for an eventual cash flow problem or to internally finance positive upcoming project ( growth opportunities), also contribute to the need of companies to hedge.
Although, the nearly unanimity of the firms’ necessity to hedge, some researchers are still sceptics for the adding value of risk management. Indeed, Modigliani and Miller (1958) talked about a theory based on market efficiency, and suggested that investors can do what managers do, by borrowing on their own account. Here, hedging is considerate as pointless partly because of the financial cost (agency costs) commonly associated to hedges, and on the assumption that managers often do not work for shareholders best interest, but would take up higher risk with high cost to serve their own goals, to demonstrate professional competence for self-esteem or to enter into hypothetic contract where risks cannot be correctly assess due to hazardous future. Smith and Stulz, (1985) have even insinuated that managers have immediate interest in the company well-being, since they can’t substitute

Show More

Credit Risk Management In The Financial Markets

Sub-Prime Mortgage Essay

Risk and Risk Management Essay

Disadvantages Of Risk Management

Importance Of Hedging

Essay on Risk Management

Audit in Non Profit Organization Essay

Essay about Ppt Ch14

Financial Management Essay

Audit: Auditing and Internal Controls Essay