Question

Describe a business practice that would help a company manage each of the following financial risks:
(a) liquidity risk
(b) interest rate risk
c) credit risk.

Answer 1

a) Liquidity risk :

Liquidity risk is the risk where the entity fails to meet its short term financial commitments. The business practice to manage is :

The company must always take into account the current ratio and ensure that it is well within the limit. The company must also have contingency plans in place to tackle the uncertain circumstances.

b) Interest rate risk :

Interest rate risk is the risk which pertains to the change in value of its investments or expense due to change in the market interest rates. The business practice to manage the same is :

It can be hedged through interest rate swaps. Interest rate swaps enables you to exchange interest on notional amount with the banker. This will help you to convert the fluctuating interest to an unfluctuating interest.

c) Credit risk :

Credit risk referes to the risk of your customer unable to fulfill the credit obligation. The business practice that would help the company to help a company is :

The company must evaluate the credit rating or the financial ability of the customer before extending the credit. Thorough background check needs to be performed at the beginning. The compnay can also attach security with the credit to reduce the credit risk.