Risk Management, Risk in Investing in Real Assets - Essay Example

?Risk Management Question There is more to the determination of which of the two projects would fetch shareholders much wealth than the amounts of money being invested into the various projects and the expected Net Cash Flow. This hidden factor is the risk associated with each of the projects and this is where the principles of cash assets pricing model plays a lot of important role. The company is advised to invest in the acquisition of the new business in the Latvian logistics because that will increase the overall real assets of shareholders. Again, the company will be in a position to bargain on the premium they would put on the acquisition through the principles of CAPM to ensure that they “demand additional expected return if they are asked to accept additional risk” (Pahl, 2007). The risk in investing in real assets is different from investing in financial securities because the rates of revenue generation associated with the two are different. Generally, real assets investment requires a lot of factors that determine profit. Some of these factors, which include staffing could be expensive and if not done well affect the revenue fortunes of the company. The risk with real assets is therefore higher. Question 2 In terms of acquiring the Latvian logistics business, the company faces business risk, which is posed against the market performance of the acquiring company. With reference to this particular risk, it is advised that “good fundamental analysis and careful selection of equities are the best ways to minimize this risk” (Noble Trading, 2009). Valuation is another risk that is associated with the Latvian acquisition. The company must be in a position to undertake comprehensive valuation that factors in the unseen cost of risks so that the final quote of the project will be one that assures value for money. With reference to the Kazakhstan subsidiary investment, some of the risks associated are inflation and interest rate risks, and market risk. This is because this investment is going into an existing business that is founded by the company in question. The single reason why it is important to have an integrated risk mitigation strategy is that the company is undertaking two different forms of investments which need an integrated strategy that caters for all the different investments. Question 3 Knowing that the risk-return trade off principle generally deals with the corresponding rises in return when there is an increase in risk, it would be right to argue that the management of working capital is the ultimate risk-return trade off for financial managers because the working capital is the single most reliable source of funding that financial managers can boast of. All other funds such as credits only come in as liabilities that need to be defended. Therefore, the harder financial managers try to take risk with their capitals and try to overcome the risks, the more they will count their returns. It is advised that the working capital of the company should be managed in such as way that it would have a correspondence with market dictates. This means that the company should pump in much fund into real asset investment if that sector shows signs of market boom. The switch should go to financial securities if that sector also shows signs of good performance. In simple terms, the working capital of the company should chance gloomy market. Question 4 The CAPM model distinguishes between specific risk and systematic risks because of the parameters under which each of these risks occur. Generally, specific risks are more attributed to managerial and other human control risks such as mismanagement which causes variation in the aggregate of productivity whiles systematic risks are associated with “variation in an asset's value caused by unpredictable economic movements” (cooper, 2012). To the investors, there is an implication which is, there are moments that their own actions can create risks and so as much as possible, they should always look for ways of minimising such specific risks. Investors are seen as risk adverse because they are the direct losers when risks are not well monitored and turn out to bring about losses. As for speculators, they are regarded as risk seekers because they always seek the presence of risk because it brings them gains in their small-cap and international stock investments. it is important for investors to consider the risk premium when choosing between two different investments because the risk premium presents them with the opportunity of determining the expected returns on the given investments. This way, the investor will be in a position to identify whether or not the named investment would result in some losses or has the potential through its expected returns to surpass identified returns on a risk-free asset. Question 5 There are three major risks that the company is exposed to. First is economic risk. With the experience of the global economic crunch, which had an adverse effect on almost all financial investments including bonds and stocks, there is every indication that economic risk is a major risk that the company faces in investing its pension funds into stocks. The second risk has to do with inflation. It has been said that inflation is everyone’s tax, which destroys value and creates recession (Little, 2012). What this means is that the actual value of the investment that the company is about to go into may be dictated by inflationary rates and this may be a very negative development for the company. The final risk that the company faces is market value risk. One of the demerits that have always accompanied financial securities investment as against real asset investment is that investors do not have much control over the market value gymnastics. This means that the market may turn against the investment without any form of control by the investors. To this end, it is advised that investing the money into real asset investment would be the best. At worse, inflation and interest rate increases will only push the market value of those investments up. Question 6 Among the three currencies, the liquidity risk may go very much against the Sterling as preferred to the Dollar and Euro deposits. This is because the Dollar and Euro have wider market usage than the Sterling though the Sterling presents very huge market value. This assertion is made against the backdrop that liquidity risks basically concerns how quickly the security can trade on the market. For the security to trade quickly, there must be a higher demand for it and this is why the Sterling would loss against the Dollar and Euro in terms of the most viable market option. Question 7 Zenzo and Kerry (2009), identifies the London Stock Exchange as one of the worse offenders when it comes to the practice of reactive corporate governance instead of proactive corporate governance. In all, proactive corporate governance has been identified as a very strong tool for ensuring that investors have trust in various financial investments, especially the stock market. With a reactive corporate governance plan, it will be virtually impossible to proof a point to clients and investors of the strength of the market to resist market risks that are causes as a result of various forms of mismanagement. It is for this reason that Zenzo and Kerry (2009), state that “the LSE needs to convince its existing clientele and would be investors that it can run its affairs with proper conduct and integrity.” Question 8 Indeed companies are there to make profits but the source of all profits is the people who do business with the companies. It is for this reason that it is always prudent for companies and corporate institutions to take a break to put in strategies that seek to address the very needs of people around them. By people around them, reference is being made to employees in the form of corporate responsibilities and customers in the forms of social responsibilities. Such responsibilities create very good image of companies in the sight of employees and customers. It therefore goes a long way to become a competitive advantage over competitors. There is evidence of this in most parts of the world including the United States and the United Kingdom where major companies have come up with social responsibilities against environmental degradation. As a response, customers have seen the need to do business with such companies as they have proof beyond doubt that they have the welfare of the populace at heart. Question 9 Corruption is one of the cankers that can best be compared to the practice of trying to fill a perforated can with water when it takes place with corporate organisations and sectors of the economy. This is because corruption retards growth and makes it almost impossible to hit set targets. With corrupt practices in place, the economies of various countries become the worse losers because monies and revenues that are due for government portfolios never get there. In terms of international trade, countries that have very bad records on corruption are often boycotted by investors. This means that such countries lack foreign direct investment and therefore loss up on international trade. Question 10 Within the corporate set up, social risk management may be described as a phenomenon that seeks to ensure the wellbeing of employees within their social context under the social protection framework. This means that the best way an employer can promote the social risk management of his employers is by making enough room for the employees to adapt socially. Invariably, such an adaptation cannot take place if the employees do not have adequate likeness and satisfaction for some key areas of their social lives including home ownership, disability status, age, job placement and location. It is for the need to ensure that a single risk management plan takes care of all these needs that demographic changes are admonished. This is because with demographic changes, all such social needs will be catered for. For instance in developing countires, the provision of basic living amenities and benefits for employees to improve their commitment levels are being encouraged by the World Bank (Zenzo and Kerry, 2009). Happily, it is on record that these demographic changes have led to increased productivity in most corporate institutions. Question 11 Options are considered viable depending on the context in which they are used. As with insurance, Sohnke (2006) notes that “options are very versatile risk management instruments that can be used to hedge various types of exposures, linear as well as nonlinear.” This means that the best form of exposures that options should be used in curtailing are those exposures that are generally discibed as uncertain. It would be noted that uncertainties arise as a result of price and quantiy risks. If well utitlised in such as context but not outside it, it would just be right to argue that options can best be compared with insurance as a risk management tool to achieve desirable results. REFERENCE LIST Zenzo D. and Kerry E. H., 2009, Assessing Corporate Governance and the London Stock Exchange: A Historical Analysis. International Journal of Applied Finance for Non-Financial Managers (ISSN: 1742-528X) Volume 1 Issue 3 Little K, 2012, Major Types of Risk for Stock Investors [Online] http://stocks.about.com/od/tradingbasics/a/Typesrisk120704.htm [May 20, 2012] Cooper R. A., 2012, Capital Asset Pricing Model [Online] http://www.referenceforbusiness.com/encyclopedia/Bre-Cap/Capital-Asset-Pricing-Model-CAPM.html [May 21, 2012] Nadine Pahl, 2007, Principles of the Capital Asset Pricing Model and the Importance in Firm Valuation, Munich, GRIN Publishing GmbH Sohnke M. B., 2006 "The use of options in corporate risk management", Managerial Finance, Vol. 32 Iss: 2, pp.160 - 181 Noble Trading, 2009, Different Risks Associated with Investing [Online] http://blog.nobletrading.com/2009/02/different-risks-associated-with.html [May 21, 2012] Read More