Financial Risk Management

 

Risk management – systematic and repetitive set of interrelated activities designed to manage potential risks, thus limit the probability of their occurrence or reduce their impact. The purpose of risk management is to avoid problems or negative effects and avoid crisis management. Risk management consists of four interrelated phases: risk identification, risk assessment, risk management (or mitigation of its impact) and risk monitoring.

 

Risk Management Strategy – a comprehensive view to the financial strategy with the goal to assess and influence the uncertainty resulting from fluctuations in exchange rates and interest rates to which the company is exposed. Risk management strategy defines how the company assesses the risks it takes, and how it faces them. We can recommend the appropriate level of risk exposure and elaborate the overall strategy, including rules for management of particular risk categories according to their importance to the company.

 

The introduction of organizational and process risk management model – depending on the size of the company and its business model, we recommend an appropriate model to cover the risk management: Director of Risk Management, Risk Department and splitting the responsibilities between the managers. We propose also risk management processes in the company together with amendments to the relevant individual job descriptions.

 

Audit of the effectiveness in communication – we evaluate the flow of information, implement and develop a planning database and effective communication and information processes.

 

Risk management – protection against the risk or control of risks arising from exchange rate and interest rate fluctuations, is the primary part of the trading. Its aim is to optimize the size of positions to maximize profits and minimize losses. Already, we have to emphasize the basic premise of a successful management on which to a significant extent depends our success or failure:

 

“Minimize your loss if you are wrong about the development of the financial market. Conversely, if you’re right and entered into a trend, you should not only keep your position but sometimes even increase its volume.”

Market Risk

 

Risk categories:

 

• Credit risk: Concentration risk, Consumer credit risk, Credit derivative, Securitization

 

• Market risk: Commodity risk (e.g. Volume risk, Basis risk, Shape risk, Holding period risk, Price area risk), Equity risk, FX risk, Margining risk, Interest rate risk, Volatility risk,

 

• Liquidity risk (e.g. Refinancing risk)

 

• Operational risk: Operational risk management, Legal risk, Political risk, Reputational risk, Valuation risk, Profit risk, Settlement risk, Systemic risk

 

• Modeling: Market portfolio, Modern portfolio theory, RAROC, Risk-free rate, Risk parity, Sharpe ratio, Value-at-Risk (VaR) and extensions, Profit at risk, Margin at risk, Liquidity at risk

 

• Basic concepts: Diversification, Expected return, Hazard, Hedge Risk, Risk pool, Systematic risk

 

• Accounting / Trading foreign exchange risk (FX risk resulting from trading activities)

 

Market risk is the risk that the value of an investment will decrease due to moves in market factors. Volatility frequently refers to the standard deviation of the change in value of a financial instrument with a specific time horizon.

 

What is the difference between the accounting and trading foreign exchange risk?

 

Foreign exchange risk is caused by continuous fluctuations of the exchange rates of the domestic currency against foreign currencies. Emerging business exchange losses bring companies to losses; in extreme cases they can even threaten the very existence of the company.

 

In contrary to the accounting foreign exchange risk that arises as the difference between the exchange rate on the day of the billing/invoice posting at the day of payment/invoice cashing, can the trading foreign exchange risk be eliminated through correct management, respectively sales gains can be increased.

 

This is ultimately reflected in maintaining the calculated profit margin of the merchant, eventually its increase without moving the fixed purchasing / selling price:

• accounting exchange rate risk affects the tax basis in the accounting
• business exchange rate risk affects cash flow through the profit margin

Financial Risk Strategy

 

• a comprehensive view on the financial strategy to assess and influence the uncertainty resulting from fluctuations in exchange rates and interest rates which the company is exposed

• it defines how the company assesses the risks it takes, and how to face them

 

• determines the appropriate level of risk exposure and processes the overall strategy, including rules for management of the particular risk categories according to their importance to the company

 

 

External strategy (financial markets)

 

• the timing of foreign exchange transactions is not related to the time of invoice payment respectively invoice cashing

• monitoring and decision making by developments in financial markets, technical analysis and mathematical models

 

• access to financial markets via bank, selection of the appropriate bank and suitable product

 

 

 

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Internal strategy (within the company)

 

• planning, calculations and pricing, determination of invoicing currency, financing, accepts the given due dates of suppliers’ and customers’ invoices
• monitoring the business exchange rate risk and its quantification - affects the price of sales and purchases
• part of a financial and business strategy
• fundamental basis for the financial risks management
• “right hand” of the Chief Financial Officer
• “left hand” of the Business director

Benefits of Active Risk Management:

 

• achievement of the defined eventually a better result of the client’s activity according to the calculated exchange rates on all business transactions, even once-off

 

• impact on the conclusion of commercial contracts in various currencies

• the use of financial strategies to achieve better business conditions

 

• knowledge of current risk exposure and the its annual change in all currencies

• open foreign currency position vs. closed - the ratio determined on the basis of financial strategy

 

• understanding of key risks threatening to achieve the goals of the company

 

• ability to identify risks, to be aware of their impact, and define how they are treated

 

• possibility to use dependencies between risks in their treatment

 

• increase the credibility of the company to shareholders, financial institutions and public

 

• stable value of the company in case of entry of an investor