Financial Risk Management Dr Asmaa Mohamed Wahba Remember

Financial Risk Management Dr. Asmaa Mohamed Wahba

Remember Financial Risk Pure Risk Speculative Risk Slide 2 from 13

The Scope of Risk Management Ø Risk management was limited in scope to pure risk, including property risks, liability risks, and personnel risks. Ø In the 1990 s, many businesses began to expand the scope of risk management to include speculative financial risks. Slide 3 from 13

Speculative Financial Risk Management Ø Business firms face a number of financial speculative risks. Ø Financial risk is arising from financial variables and involves financial loss. Ø Thus, the expression Financial Risk Management is commonly used instead of the expression Speculative Financial Risks Management. Slide 4 from 13

Financial Risk include ØTherefore, Financial risk can be classified as following: Market risk Credit risk Liquidity risk Slide 5 from 13

ØMarket risk: arises from the adverse changes in the market prices or variables. ØCredit risk is the risk of loss arising from the failure of an external party (counterparty) to make a promised payment (contractual obligations). Slide 6 from 13

Ø Liquidity risk: the risk of loss arising from a lack of cash or equivalents (inability to obtain funding, or sell or pledge an asset at fair value, in order to cover an expected or unexpected obligation). Ø Liquidity risk can therefore be considered as the risk of economic loss suffered in attempting to secure the cash that is so vital to business operations. Slide 7 from 13

Market risk Ø Market risk: as we mentioned before, market risk arises from the adverse changes in the market prices or variables. q Examples: o. Commodity o. Interest rates risk. o. Currency o. Stock prices risk. exchange rate risk. prices, and so on. Slide 8 from 13

Market risk Ø Commodity Price Risk prices risk: is the risk of losing money if the price of a commodity changes. Ø Commodity price risk is a significant problem for firms as a consumer or as a seller. o consuming firms use raw materials for its production may face increased production costs due to changing in commodity prices. o producing firms that sell commodities are exposed to price falls which mean they will receive less revenue for the commodities they produce. Slide 9 from 13

Commodity Price Risk Examples: Ø Construction Company, which promised to deliver a number of housing units during a certain period, during this period the price of building materials changed, it affected on profitability of the transaction. Ø Consider an agricultural operation that will have a large amount of crop at harvest time. At harvest, the price of the crop may have increased or decreased, depending on the supply and demand for crop. Because little storage is available for the crop, the crop must be sold at the current market price, even if that price is low. Slide 10 from 13

Market risk Ø Interest rate risk: is the risk of loss caused by adverse interest rate movements. Ø Interest rate risk have a big impact on company’s profitability, both as a the borrower or lender (investor ). o The borrower can face increased costs as a result to an adverse movement in interest rate. o The lender (investor) can face reduced returns as a result to an adverse movement in interest rate. Slide 11 from 13

Currency Exchange rate risk Market risk ØCurrency exchange rate risk : is the risk of loss of value caused by changes in the rate at which one nation's currency may be converted to another nation’s currency. ØThis is a big risk factor for businesses Specially multinational companies, export and import companies. Slide 12 from 13

Managing Financial Risks Ø The methods of pure risk treatment that have previously already mentioned, as risk retention, risk transfer, and risk control. Differently, Speculative financial risk is treating by contractual provisions and capital market instruments (Forward contracts, Futures contracts, Swaps contracts, Options contracts). Slide 13 from 13