Identifying and Managing Risk - Research Paper Example

The market risk is associated with the uncertainties in the areas of foreign exchange rate fluctuations, fluctuation of interest rates, fluctuation of stock prices and commodity prices. The market risk is managed by the use of interest rate swaps, options and future. The use of derivatives in financial market is important to hedge market risks. The risk management techniques are used to reduce the credit risk of the organization which occurs as a result of default of the counterparties. The credit ratings are used to assess the credit risk of organizations.

The credit risk is reduced by limiting the exposure to the parties considered to be risky for repayment (Deventer, Imai and Mesler, 2013). The other credit risk management tools used are by the use of collaterals, periodic marking to the market, captive derivative subsidiaries and netting. Netting is a risk management technique through which the amount of cash owed by one party to another is reduced by the amount by the latter to the former. There are various methods of netting which includes bilateral netting, multilateral netting, payment netting, cross product netting and close-out netting.

Several types of derivatives like over the counter derivatives and credit derivatives are used to mitigate the exposure to credit risks. The types of credit derivatives include Total return swaps, Credit Swaps and Credit Options. Several authors have explained different financial risk management techniques that are widely used in the industries. Analysis: Comparison of financial risk management techniques A comparison of the financial risk management techniques explained by Kallman to that of Cohen and Palmer is given below.

Kallman explained that we should a clear idea of the nature of risks that need to be mitigated. According to Kallman, the risk exposures could be categorized into strategic risks, operational risks and economic risks. The strategic risks are the uncertainties that rise in the long term. These may be quality risk, brand risk, etc. The operational risks are the uncertainties that occur within a single operating period as a result of the operations of the company. The economic risks are the areas of uncertainty created as a result of volatility in political and financial conditions (Kallman, 2007).

These risk exposures are mainly due to the changes in macro and micro economic conditions. The economic risks take the form of interest rate risk, foreign exchange risk, etc. The risk exposures may be pure which results in a loss of values or speculative which may either result in a gain or loss. The popular risk management tools proposed by the author are risk surveys and checklist. The survey and checklist are important tools to build a risk register in the organization. Flowcharts of organizational process are useful in identifying the risks involved.

After identification of risk, the risks are managed by risk management techniques that include statistical analysis, financial statement analysis and also personal inspection. The risk management techniques explained by Kallman could be compared to the risk management techniques explained by Cohen and Palmer. According to Cohen and Palmer, the