Positives and negatives of risk management essay

1 . zero The pros of risk management

Maintaining competitiveness

Undesirable changes in interest and exchange rates may reduce the competitive position of a company against those with reduce levels of gearing or more compact exchange rate exposures, or compared with companies that have taken the preventative measure of hedge against level changes.

Decrease of bankruptcy risk

Undesirable movements in interest and exchange costs may endanger the continued operation of a organization. A classic case in point is that of a highly geared organization with a large proportion of floating charge debt being forced into personal bankruptcy due to a rise in interest rate.

Restructuring of capital responsibilities

Interest rate hedge instruments can be used to restructure a company’s capital profile simply by altering the nature of its interest obligations, thereby avoiding the repayment of existing debts or the providing of new securities. In consequence, extensive savings may be made in esteem of call up fees and issue costs. At the same time, a wider selection of financial sources becomes available to the company.

Minimizing in the unpredictability of business cash flows

Reducing the volatility of net cash flows may well increase the industry rating in the company and can facilitate the process of forward preparing.

2 . zero The disadvantages of risk management

The challenging nature of hedging tools

A combination of unfamiliarity with the selection of hedging methods available and a perception by potential users that such strategies are complex may result in treasurers picking not to hedge exchange and interest rate exposures.

The risks linked to using external hedging devices

The identified risk linked to in applying hedging tools can sometimes deter potential users. Instead of rendering protection from considerably increasing rates of interest, the transactions turned out to be remarkably speculative gambling bets.

The complicated tax and financial confirming treatments of derivatives

The accounting and tax remedying of derivatives offers tended to lag at the rear of the rate of their creation owing to the dynamic nature of their markets. The major problem regarding the accounting treatment of derivatives is understanding exactly what info to disclose and the way to disclose that.

Diversification simply by shareholders can be superior to hedge

An alternative to hedging by specific companies is good for shareholders to diversify aside interest and exchange price risk themselves by possessing a varied portfolio of shares, therefore saving the expenses associated with hedge at a corporate level. If shareholders hold diversified portfolios, some commentators argue that hedging of exposures by individual companies is motivated purely by management’s desire to secure their jobs, rather than a wish to enhance shareholder wealth.

a few. 0 Summary

As a summary, exchange charge risk and interest rate risk can be managed by the use of the two internal and external tactics. Internal methods allow firms to hedge risk inside their own balance sheet by the way by which they structure their assets and liabilities. Alternatively, companies may employ one or more of the many external techniques available nowadays, such as trades, options, futures and forwards. While these derivative instruments give even more scope and flexibility to companies to manage their risk, all their associated costs and their challenging nature should be taken into account.

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