W1-Risk Management Process.pptVIP

An Introduction to Derivatives and Risk Management, 8th ed. An Introduction to Derivatives and Risk Management, 8th ed. Risk Management  Risk management is not about avoiding risk. Rather, it is about understanding and communicating risk, so that risk can be taken more confidently and in a better way Definition of risk management: The practice of defining the risk level a firm desires, identifying the risk level it currently has, and using derivatives or other financial instruments to adjust the actual risk level to the desired risk level. What is Risk Management? Why Practice Risk Management? The Impetus for Risk Management Firms practice risk management for several reasons: Interest rates, exchange rates and equity prices are more volatile today than in the past. Significant losses incurred by firms that did not practice risk management Improvements in information technology Favorable regulatory environment Sometimes we call this activity financial risk management. Why Practice Risk Management? The Benefits of Risk Management What are the benefits of risk management, in light of the Modigliani-Miller principle that corporate financial decisions provide no value because shareholders can execute these transactions themselves? Firms can practice risk management more effectively. There may tax advantages from the progressive tax system. Risk management reduces bankruptcy costs. Managers are trying to reduce their own risk. Why Practice Risk Management? The Benefits of Risk Management By protecting a firm’s cash flow, it increases the likelihood that the firm will generate enough cash to allow it to engage in profitable investments. Some firms use risk management as an excuse to speculate. Some firms believe that there are arbitrage opportunities in the financial markets. Types of Risks Operational risk system and control risk management failure risk human error risk Market risk: the uncertainty associated with interest rates, foreign exchange rates, equity