Managing Financial Risks With Derivatives - Thesis Example

According to the research findings in the current business environment markets have become increasingly global. Global data is increasing very fast with the establishment of a number of multinational companies. Although financial risk has increased significantly in recent years; risk and risk management are not contemporary issues. The result of increasingly global markets is that risk may originate with events thousands of miles away that have nothing to do with the domestic market. Quick changes in market reactions can be expected with availability of instantaneous information.

The economic climate and markets can be affected very quickly through changes in exchange rates, interest rates, and commodity prices. Counter- parties can rapidly become problematic. As a result, it is important to ensure that financial risks are identified and managed appropriately. Preparation is the key component of risk management. Derivative is the widely used strategy adopted for risk management. It tends to avoid or minimize risk occurrences faced by the institutions. Usage of proper derivative instruments provides advantages of cheaper foreign exchange, cheaper interest rate and an opportunity to sell shares at flexible prices.

Derivative instruments tend to transfer risk from the user to the providers. It is traded widely among financial institution and exchanges. Derivatives play a fundamental part an important role in the risk management of equity, bonds, or short term interest rates. Use of derivative instruments like futures, forward, hedging, and swaps comes into play for effective control of financial risks (grammar mistakes in this sentence). Derivative instruments like futures, forward, hedging and swap can be used effectively to control financial risks.

Many The various financial risk (sense??????????) Many risk elements that exist in the market are like credit risk which arises from the potential that an obligor is either unwilling to perform on an obligation or its ability to perform such obligation is impaired resulting in economic loss to the bank. Besides market risk is the risk that the value of on and off-balance sheet positions of a financial institution will be adversely affected by movements in market rates or prices such as interest rates, foreign exchange rates, equity prices, credit spreads and/or commodity prices resulting in a loss to earnings and capital.

liquidity risk is the potential for loss to an institution arising from either its inability to meet its obligations or to fund increases in assets as they fall due without incurring unacceptable cost or lose operational risks " is the risk of loss resulting from inadequate or failed internal processes, people and system or from external events " (Risk Management Guidelines for commercial Banks &