Question

Your mandate (task for this assessment item) is to prepare a ‘Business Case’ with recommendations for your board that pitches the need for a systematic financial risk management strategy and the financial derivatives and tools that could be used as part of this strategy. The business case should focus on the next 12 month period. This business case should be
prepared as a report. The structure of the report should be appropriate to your audience, include an executive summary and address each of the following questions.

Question
- Outline and explain the risks associated with the fixed income security the company has purchased. Use examples of possible scenarios that may occur for SSP to illustrate the nature

- Present some alternatives the company may look into to protect itself against interest rate rises associated with debt funding for the new investment project.

Answer 1

Answer:

Preparing a business case involves an assessment of:

Business opportunity & problem, Benefits, Risk, Costs, Technical solutions, Operations and firms capability to deliver the project outcomes.

Risk associated with the fixed income security are-

Fixed Income security is an investment technique that provides us a return in the form of periodic payments which is fixed.Tthe payments of a fixed income security are known in advance. The most common fixed income security is a bond.

Risk is the potential event which may have an adverse impact on your investments. Interest rate fluctuations and exchange rate fluctuations are the most common risks involved in a bond. Interest rate fluctuations may cause a change in bond prices which will result in low income.Bonds issued by a high risk firm may not be repaid sometimes which will result in loss of principal amount and interest. Investing in bonds may result in losses due to exchange rate fluctuations.

Example: If an European investor owns bonds from India, which is denominated in Rupees, and the Rupee value decreases in relative to the Euro, the investors reurns will be reduced.

Some alternatives for a company to protect itself are:

- While investing in debt funds, look at the ones with a short maturity. They should invest in short term funds and corporate credit funds. These will deliver the best interest in the current market and can protect the company or investors from the chnage or rise in interest rates.

- They should not invest in long term bond funds as they depreciate in high interest rate situation which will result in loss of income.

- A company should look to invest in liquid funds, short term funds and a fixed maturity plans.

Summary-

The need for a systematic financial risk management strategy and the financial derivatives and tools in the business is a function which has become an important characteristic of many large firms. This technique has been proven as relevant in making financial risk management decisions. Adding some of the financial derivative instruments available to the portfolio of your investments will help in global diversification. Price discovery and risk management are some of the benefits of using financial derivative instruments.