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Strategic Financial Management - Essay Example

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With the passing time the importance of hedging against risk is increasing multi-fold especially for the financial Institutions. There are several reasons why firms may choose to hedge risks, and they can be broadly categorised into five groups. First, the tax laws may benefit those who hedge risk…
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Download file to see previous pages Fourth, minimising the exposure to some types of risk may provide firms with more freedom to fine-tune their capital structure. Finally, investors may find the financial statements of firms that do hedge against extraneous or unrelated risks to be more informative than firms that do not may.
With the increasing awareness and concerns from the customers the financial institutions are required to disclose information at higher scale at the same time the security of information is an important concern. This not only increases the concerns of the customers but also increase the need of information provision by the financial institutions in order to open themselves up to customers and partners for revenue growth. I hope that the readers and the concerned people will find this information useful and that it helps establish organisational direction for a very complex issue.
Derivatives have been used to manage risk for a very long time, but they were available only to a few firms and at high cost, since they had to be customised for each user. The development of options and futures markets in the 1970s and 1980s allowed for the standardisation of derivative products, thus allowing access to even individuals who wanted to hedge against specific risk. The range of risks that are covered by derivatives grows each year, and there are very few market-wide risks that you cannot hedge today using options or futures.
In 1999, Mian studied the annual reports of 3,022 companies in 1992 and found that 771 of these firms did some risk hedging during the course of the year. Of these firms, 543 disclosed their hedging activities in the financial statements and 228 mentioned using derivatives to hedge risk but provided no disclosure about the extent of the hedging. Looking across companies, he concluded that larger firms were more likely to hedge than smaller firms, indicating that economies of scale allow larger firms to hedge at lower costs. (Mian, 1996) As supportive evidence of the large fixed costs of hedging, note the results of a survey that found that 45% of Fortune 500 companies used at least one full-time professional for risk management and that almost 15% used three or more full-time equivalents. (Dolde, 1993)
The evidence on whether risks hedging increases value is mixed. In a book on risk management, Smithson presents evidence that he argues is consistent with the notion that risk management increases value, but the increase in value at firms that hedge is small and not statistically significant (Smithson, 1999).
In summary, the benefits of hedging are hazy at best and non-existent at worst, when we look at publicly traded firms. While we have listed many potential benefits of hedging including tax savings, lower distress costs and higher debt ratios, there is little evidence that they are primary motivators for hedging at most companies. In fact, a reasonable case can be made that most hedging can be attributed to managerial interests being served rather than increasing stockholder value.
The questions need to be answered while undertaking the study will be as follows:
What is risk What are the regulatory requirements for global financial institutions How does Information security risk affect financial institutions What are the Confidentiality risks What are the Availability ...Download file to see next pagesRead More
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