Essay Title: 

Finance – Risk Management

April 2, 2016 | Author: | Posted in civil engineering, technology

Risk Management

Introduction

Events outside the control of a corporation can affect the firm and its financing decisions . For example , a change in the interest rate can suddenly make borrowing money very inexpensive or very costly . From 1975 to 1995 , interest rates in the United States were as high as 15 percent and as low as 3 percent . Many economic factors , such as changes in the price of oil or the price of foreign currency , can affect businesses as well (Redmond , WA , 2006

Corporate financial managers need to make sure that [banner_entry_middle]

potential economic fluctuations do not threaten the firm . A variety of tools , known as derivatives , help manage the risk of such events occurring . Four important kinds of derivatives include (1 ) futures (2 ) forwards (3 options , and (4 ) swaps . Futures are promises to buy or sell something in the future at a price that is agreed upon today . For example , a candy manufacturer might commit to purchasing a specified quantity of cocoa at a specified price from the producer in six months . Futures are traded on organized futures exchanges , such as the Chicago Mercantile Exchange or the Chicago Board of Trade . Forwards are similar to futures , but they are arranged directly between a firm and a bank . Options give a firm the right to buy or sell something in the future at a price that is agreed upon today . For example , if the candy-manufacturer does not know how much cocoa will be needed in six months , it could take out an option to buy cocoa at a certain price . Swaps involve firms swapping one set of payments for another . For example , an American firm may agree to make a series of dollar payments to a Japanese bank , while the bank in return promises to make a series of yen payments

Derivatives are very popular . For example : worldwide trading of futures amounts to about 35 trillion a year . Most firms use derivatives to reduce risk , but some use them to speculate by buying and selling derivatives in hopes of earning a profit . When these speculations don ‘t work out , losses can be substantial . For example , the United Kingdom ‘s Barings , one of the world ‘s oldest banks , collapsed in 1995 when futures speculation by one of its traders in Singapore resulted in losses of over 1 billion . Methods of corporate finance continually evolve as financial managers invent new ways to raise money and avoid risk . Smart investment and financing decisions are crucial to a firm ‘s success (Redmond , WA , 2006

Risk analysis

To help individuals and businesses manage risk , providers of insurance must have ways of determining what kinds and degrees of risk different people and businesses face . To do this , insurers rely on the basic principle of grouping together similar risks . By examining the risks faced by a variety of individuals and businesses , insurers can establish common risk pros (patterns of characteristics . With this information , an insurer can quickly determine what kind of insurance to offer someone applying for a… [banner_entry_footer]

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