Question

create a profile of risk management strategy of a company.  select from the following topics to address in your profile.

• How does the firm think about risk? What types of risks does the firm attempt to hedge?
• Which of the tools (forward contracts, futures, swaps, options) does the firm uses?
• Is the firm's board of directors involved in enterprise risk management?
• Does the firm have a chief risk officer (CRO)?

minimum 350 words

Answer 1

Boradly defined, risk is the possibility of happening of a bad event. In the context of business, risk can be classified into:

• Credit Risk - Failure of one party to fulfiil financial obligations
• Market Risk - Unexpected change in market values of assets and their variables
• Operational Risk - Loss resulting from failed internal processes

The right approach for a firm to manage risk is to indentify and classify risk into as many material sub divisions as possible and analyze each division from a bottom-up approach. The second step is to aggregate the risk at organizational level. This might lead to some risks being cancelled out, some categories emerging more improtant than others.

Hedging risk means taking steps to minimize the impact of a negative event. The objective of this exercise should be to manage the quantum of losses and being certainity in the business rather than profit making.

Use of hedging tool depends on a case-to-case basis as under:

• Forwards - This contract enables one to fix a price for an asset to be exchanged at a future date and does not involve any upfront cost but is marred with counterparty risk.
• Futures - Similar to forwards, these are traded in stock echanges. These are standardized and free of counterparty risk
• Options - These contracts give the buyer the option to exchnage an asset at a fixed price on a future date. These involve an upfront premium but gives buyer operational flexibility i.e. loss is capped at premium paid by the buyer.
• Swaps - These contracts are a series if forward agreements enabling exchange of a series of future cashflows.

Involvement of the board in enterprise risk management is of utmost importance for effective risk management.