Question

three methods of managing risk

three methods of financing losses are retention, insurane and hedging. Discuss how they apply to the treasury risk manager

Answer 1

Treasury risk mangement is the mangement of risk associated with mangement of financial holding be it money market or stocks or long terms bonds or matching the timing of cash Inlfow or cash outflow. The method of risk mangement are universal and their application can be made to every area with little or no modification. The three key methods of managing risk are retention, insurance, and hedging.

Retention: The retention of risk means that sometimes the cost of avoiding the risk is far more than keeping the risk as it is, in that case not avoiding the risk is better. For example, a treasury manager in US is about to receive 100,000GBP from UK and he is concerned about the exchnage rate but the cost of hedging the cashflow in USD terms 50,000USD, in this case it is betternot to hedge your cash flow position.

Insurance : Insurance is basically done for events which might or might not occur in future but if they do occur they can cause significant cash outflow. For example fire Insurance, property Insurance. Most of the enterprise go for fire insurance, even when they have adequate measures to protect their building from fire. Tresury manager when they are about to receive cashflow in 5 years or 7 years buy or sell future contract to protect their position.

Hedging: The idea behind hedging is to transfer some of the risk from your portfolio by letting go some of the returns. Most treasury manager when they have to manage cashflows, they look for ways where they can reduce the uncertainity in inflow or outflow of cash. Lets suppose a treasury manager in US is about to 1,000,000 GBP from UK customer. Normally they would enter into a future contract where they can hedge the unceratinity regarding the cash flow in dollar.