HAF 422 ASSIGMENT NO TWO

1. Explain what Financial Risk Management is?

Financial risk management is the method of understanding and dealing with the financial risks that your
enterprise is probably dealing with both now or with inside.

It is the process of identifying risks, analyzing them and making investment decisions based on either
accepting, or mitigating them. These can be quantitative or qualitative risks, and it is the job of a Finance
manager to use the available financial instruments to hedge a business against them.
Financial risk management involves identifying the risk, measuring it, evaluating all possible remedies,
developing a strategy and then implementing the steps and financial instruments necessary to minimize
potential ramifications.

2. Discuss why Financial Risk Management is critical to the survival and growth of an organisation.
The Importance of Financial Risk Management -It helps keep businesses stable in an
unpredictable financial landscape by minimizing potential risks. In a complex and
volatile market, effective risk management not only protects assets but also boosts
profitability and assists in making informed decisions.
Why is financial risk management important in an organization?
The role of risk management in finance is to identify and manage the risks associated with financial
decisions and decisions related to finance. The primary role of risk management is to ensure that a firm's
financial decisions are made in a way that is consistent with the firm's goals and objectives.
Why risk management is critical?

It helps in calculating the uncertainties and also predict their impact, consequently giving organizations a
basis upon which they can make decisions. It prepares the organization for the unexpected by mitigating
or minimizing the impacts of risk even before it occurs by acting proactively rather than reactively.

3. Give a brief historical background (Maximum three paragraphs) of Financial Risk Management
Financial risk management is the practice of protecting economic value in a firm by managing exposure
to financial risk - principally operational risk, credit risk and market risk, with more specific variants as
listed aside. Therefore, risk management appears in scientific and management literature since the
1920s. It became a formal science in the 1950s, when articles and books with “risk management” in the
title also appear in library searches. The study of risk management began after World War II. Risk
management has long been associated with the use of market insurance to protect individuals and
companies from various losses associated with accidents.

However, modern risk management started after 1955. Since the early 1970s, the concept of financial
risk management evolved considerably. Notably, risk management has become less limited to market
insurance coverage, which is now considered a competing protection tool that complements several
other risk management activities. Initially, risk management was associated with the use of insurance to
protect assets, individuals, and companies from various types of potential losses associated with
different incidents and accidents.

The role of risk management in finance is to identify and manage the risks associated with financial
decisions and decisions related to finance. The primary role of risk management is to ensure that a firm's
financial decisions are made in a way that is consistent with the firm's goals and objectives.It helps the
firm to coordinate and control necessary business data and processes. It provides a better
understanding of the opportunity for performance measurement and profit sources. You can link your
economic cycle with the factors of model risk.

4. State and explain the types of risks that an organization faces.

The main four types of risk are:
 strategic risk - eg a competitor coming on to the market.
 compliance and regulatory risk - eg introduction of new rules or legislation.
 financial risk - eg interest rate rise on your business loan or a non-paying customer.

operational risk - eg the breakdown or theft of key equipment.

Business risk comes in many different guises. While there is a certain amount of overlap between them,
they can essentially be distilled into four main categories:
1. Strategic risk
This is probably the principal type of risk in business and encompasses a lot of different elements.
Strategy is essential in shaping the direction for any organisation but in a fast-paced business climate,
things can change very quickly.
So for example, if you have introduced a new product to the market but it isn’t selling, this could be
because a competitor has introduced something that meets the same demand, it could be that the
demand isn’t there or that your product has been incorrectly targeted. The repercussions of this could
be reduced turnover and profit or even put the survival of the business at risk. Organizations must be
very mindful of this and utilizing enterprise risk management software is a highly effective way of doing
so.
2. Compliance risk
With more compliance regulation than ever before, and more complex requirements, organizations are
deploying compliance software and IT GRC tools to stay on top of their compliance requirements.
But non-compliance really is a major risk to most businesses. Compliance changes all the time and a
good example is the recent EU GDPR. This data privacy regulation means that any organisation holding
EU citizen data must notify people within three days if their data is hacked, and they also must allow
people to erase or move their personal information immediately.
This applies as much to an organisation located in the US or Africa as it does one in Europe,
and some of the recent fines highlight just what a significant threat compliance risk is.
3. Operational risk
There is also a significant amount of risk for businesses that come from their own organisation. This
could be a technical failing, an administrative error, failure to defend effectively against a cyber-
breach, employee theft or a whole range of other threats.
Anything that impacts a company’s core operations would fall into this category, and the implications of
it could be reputational, result in a failure to fulfill customer expectations and much more. Some of this
can be difficult to identify, manage and mitigate and showcases even further the need for enterprise risk
management software to help.

4. Financial risk
All types of risk contain an element of financial risk too, but the financial risk category refers specifically
to money coming into and out of the organisation, and the possibility of a sudden and unexpected
financial loss.
Examples of this could be a major customer going into receivership when owing the business a
significant amount of money, or for a company that has a lot of debt suddenly seeing a big change in the
overall economy and lending interest rates. International trading ,which is so widespread in 2019 – also
comes with financial risk, with the fluctuating currency levels that might mean a company receiving
significantly less revenue because the currency rate has gone down in that country.

5.Explain how the various types of risks can be mitigated by an organization.

How to mitigate against these risks

For any organisation attempting to manage and mitigate against these risks, enterprise risk management
software has become an essential technology. There are many GRC software vendors available and
bigger organisations will almost certainly be working with one of these, but the same might not be true
of mid-market firms.
But they still have just as big a need for enterprise risk management software, which is why Oxial and
our sGRC solution, is such an effective risk management tool. Not only is it affordable and
straightforward to install, it comes with an unparalleled range of features and functionality to help an
organisation to manage and mitigate risk.
It combines risk management into one overall IT GRC solution and its continuous monitoring of all risks
and threats to an organisation gives complete peace of mind that the business is safe from true threat.
If you are interested in similar peace of mind, why not get in touch? One of our risk management
experts is available here.

State and discuss an example of a common (well known) Financial Risk that is
taken by individuals in our various communities (Suburbs, Settlements, and
Villages) and how these individuals mitigate the risk. What Is
Financial Risk?
Financial risk is the possibility of losing money on an investment or business venture. Some more
common and distinct financial risks include credit risk, liquidity risk, and operational risk.
Financial risk is a type of danger that can result in the loss of capital to interested parties. For
governments, this can mean they are unable to control monetary policy and default on bonds or other
debt issues. Corporations also face the possibility of default on debt they undertake but may also
experience failure in an undertaking the causes a financial burden on the business.
KEY TAKEAWAYS
 Financial risk generally relates to the odds of losing money.
 The financial risk most commonly referred to is the possibility that a company's cash flow will
prove inadequate to meet its obligations.
 Financial risk can also apply to a government that defaults on its bonds.
 Credit risk, liquidity risk, asset-backed risk, foreign investment risk, equity risk, and currency risk
are all common forms of financial risk.
 Investors can use a number of financial risk ratios to assess a company's prospects.
Understanding Financial Risks for Businesses
Financial markets face financial risk due to various macroeconomic forces, changes to the market
interest rate, and the possibility of default by sectors or large corporations. Individuals face financial risk
when they make decisions that may jeopardize their income or ability to pay a debt they have assumed.
Financial risks are everywhere and come in many shapes and sizes, affecting nearly everyone. You
should be aware of the presence of financial risks. Knowing the dangers and how to protect yourself will
not eliminate the risk, but it can mitigate their harm and reduce the chances of a negative outcome.
It is expensive to build a business from the ground up. At some point in any company's life the business
may need to seek outside capital to grow. This need for funding creates a financial risk to both the
business and to any investors or stakeholders invested in the company.
Credit risk—also known as default risk—is the danger associated with borrowing money. Should the
borrower become unable to repay the loan, they will default. Investors affected by credit risk suffer
from decreased income from loan repayments, as well as lost principal and interest. Creditors may also
experience a rise in costs for the collection of debt.
When only one or a handful of companies are struggling it is known as a specific risk. This danger,
related to a company or small group of companies, includes issues related to capital structure, financial
transactions, and exposure to default. The term is typically used to reflect an investor's uncertainty
about collecting returns and the accompanying potential for monetary loss.
Businesses can experience operational risk when they have poor management or flawed financial
reasoning. Based on internal factors, this is the risk of failing to succeed in its undertakings.

Many analysis identify at least five types of financial risk: market risk, credit risk, liquidity risk,
operational risk, and legal risk.
How Governments Offset Financial Risk
Financial risk also refers to the possibility of a government losing control of its monetary policy and
being unable or unwilling to control inflation and defaulting on its bonds or other debt issues.
Governments issue debt in the form of bonds and notes to fund wars, build bridges and other
infrastructure and pay for their general day-to-day operations. The U.S. government's debt—known as
Treasury bonds—is considered one of the safest investments in the world.
The list of governments that have defaulted on debt they issued includes Russia, Argentina, Greece, and
Venezuela. Sometimes these entities only delay debt payments or pay less than the agreed-upon
amount; either way, it causes financial risk to investors and other stakeholders.
The Impact of Financial Risks on Markets
Several types of financial risk are tied to financial markets. As mentioned earlier, many circumstances
can impact the financial market. As demonstrated during the 2007 to 2008 global financial crisis, when a
critical sector of the market struggles it can impact the monetary wellbeing of the entire marketplace.
During this time, businesses closed, investors lost fortunes, and governments were forced to rethink
their monetary policy. However, many other events also impact the market.
Volatility brings uncertainty about the fair value of market assets. Seen as a statistical measure, volatility
reflects the confidence of the stakeholders that market returns match the actual valuation of individual
assets and the marketplace as a whole. Measured as implied volatility (IV) and represented by a
percentage, this statistical value indicates the bullish or bearish—market on the rise versus the market
in decline—view of investments. Volatility or equity risk can cause abrupt price swings in shares of
stock.
Default and changes in the market interest rate can also pose a financial risk. Defaults happen mainly in
the debt or bond market as companies or other issuers fail to pay their debt obligations, harming
investors. Changes in the market interest rate can push individual securities into being unprofitable for
investors, forcing them into lower-paying debt securities or facing negative returns.
Asset-backed risk is the chance that asset-backed securities—pools of various types of loans—may
become volatile if the underlying securities also change in value. Sub-categories of asset-backed risk
involve the borrower paying off a debt early, thus ending the income stream from repayments and
significant changes in interest rates.
In 2021, the U.S. high yield default rate finished at a record low 0.5%. 2022 and 2023 projections by Fitch
Solutions anticipates continual lower than average default rates.1
How Financial Risks Impact Individuals
Individuals can face financial risk when they make poor decisions. This hazard can have wide-ranging
causes from taking an unnecessary day off of work to investing in highly speculative investments. Every
undertaking has exposure to pure risk—dangers that cannot be controlled, but some are done without
fully realizing the consequences.
Liquidity risk comes in two flavors for investors to fear. The first involves securities and assets that
cannot be purchased or sold quickly enough to cut losses in a volatile market. Known as market liquidity
risk this is a situation where there are few buyers but many sellers. The second risk is funding or cash
flow liquidity risk. Funding liquidity risk is the possibility that a corporation will not have the capital to
pay its debt, forcing it to default, and harming stakeholders.
Speculative risk is one where a profit or gain has an uncertain chance of success. Perhaps the investor
did not conduct proper research before investing, reached too far for gains, or invested too large of a
portion of their net worth into a single investment.
Investors holding foreign currencies are exposed to currency risk because different factors, such as
interest rate changes and monetary policy changes, can alter the calculated worth or the value of their
money. Meanwhile, changes in prices because of market differences, political changes, natural
calamities, diplomatic changes, or economic conflicts may cause volatile foreign investment conditions
that may expose businesses and individuals to foreign investment risk.
Pros and Cons of Financial Risk
Financial risk, in itself, is not inherently good or bad but only exists to different degrees. Of course, "risk"
by its very nature has a negative connotation, and financial risk is no exception. A risk can spread from
one business to affect an entire sector, market, or even the world. Risk can stem from uncontrollable
outside sources or forces, and it is often difficult to overcome.
While it isn't exactly a positive attribute, understanding the possibility of financial risk can lead to better,
more informed business or investment decisions. Assessing the degree of financial risk associated with a
security or asset helps determine or set that investment's value. Risk is the flip side of the reward.
One could argue that no progress or growth can occur, be it in a business or a portfolio, without
assuming some risk. Finally, while financial risk usually cannot be controlled, exposure to it can be
limited or managed.
Financial Risk
Pros
 Encourages more informed decisions
 Helps assess value (risk-reward ratio)
 Can be identified using analysis tools
Cons
 Can arise from uncontrollable or unpredictable outside forces
 Risks can be difficult to overcome
 Ability to spread and affect entire sectors or markets
Tools to Control Financial Risk
Luckily there are many tools available to individuals, businesses, and governments that allow them to
calculate the amount of financial risk they are taking on.
The most common methods that investment professionals use to analyze risks associated with long-
term investments—or the stock market as a whole—include:
 Fundamental analysis, the process of measuring a security's intrinsic value by evaluating all
aspects of the underlying business including the firm's assets and its earnings.
  Technical analysis, the process of evaluating securities through statistics and looking at historical
returns, trade volume, share prices, and other performance data.
 Quantitative analysis, the evaluation of the historical performance of a company using specific
financial ratio calculations.
For example, when evaluating businesses, the debt-to-capital ratio measures the proportion of debt
used given the total capital structure of the company. A high proportion of debt indicates a risky
investment. Another ratio, the capital expenditure ratio, divides cash flow from operations by capital
expenditures to see how much money a company will have left to keep the business running after it
services its debt.
In terms of action, professional money managers, traders, individual investors, and corporate
investment officers use hedging techniques to reduce their exposure to various risks. Hedging
against investment risk means strategically using instruments—such as options contracts—to offset the
chance of any adverse price movements. In other words, you hedge one investment by making another.

Statistical and numerical analysis are great tools for identifying potential risk, but prior financial history
is not indicative of a company's future performance. Make sure to analyze trends over a long period of
time to better understand whether fluctuations (or lack thereof) are progress towards a financial goal or
inconsistent operating activity.
Real-World Example of Financial Risk
Bloomberg and other financial commentators point to the June 2018 closure of retailer Toys "R" Us as
proof of the immense financial risk associated with debt-heavy buyouts and capital structures, which
inherently heighten the risk for creditors and investors.2
In September 2017, Toys "R'" Us announced it had voluntarily filed for Chapter 11 bankruptcy. In a
statement released alongside the announcement, the company's chair and CEO said the company was
working with debtholders and other creditors to restructure the $5 billion of long-term debt on its
balance sheet.3
As reported in an article by CNN Money, much of this financial risk reportedly stemmed from a 2005 US
$6.6 billion leveraged buyout (LBO) of Toys "R" Us by mammoth investment firms Bain Capital, KKR &
Co., and Vornado Realty Trust.4 The purchase, which took the company private, left it with $5.3 billion
in debt secured by its assets and it never really recovered, saddled as it was by $400 million worth of
interest payments annually.5
The Morgan-led syndicate commitment didn't work. In March 2018, after a disappointing holiday
season, Toys "R" Us announced that it would be liquidating all of its 735 U.S. locations to offset the
strain of dwindling revenue and cash amid looming financial obligations.6 Reports at the time also noted
that Toys "R" Us was having difficulty selling many of the properties, an example of the liquidity risk that
can be associated with real estate.
In November 2018, the hedge funds and Toys "R" Us' debt holders Solus Alternative Asset Management
and Angelo Gordon took control of the bankrupt company and talked about reviving the chain. In
February 2019, The Associated Press reported that a new company staffed with ex-Toys "R" Us execs,
Tru Kids Brands, would relaunch the brand with new stores later in the year.7
In late 2019, Tru Kids Brands opened two new stores—one in Paramus, New Jersey, and the other in
Houston, Texas.8 Most recently, Macy's has partnered with WHP Global to bring back the Toys "R" Us
brand. In 2022, Macy's plans to roll out approximately 400 physical toy store storefronts within existing
Macy's locations.9
How Do You Identify Financial Risks?
Identifying financial risks involves considering the risk factors a company faces. This entails reviewing
corporate balance sheets and statements of financial positions, understanding weaknesses within the
company's operating plan, and comparing metrics to other companies within the same industry. There
are several statistical analysis techniques used to identify the risk areas of a company.
How Do You Handle Financial Risk?
Financial risk can often be mitigated, although it may be difficult or unnecessarily expensive for some to
completely eliminate the risk. Financial risk can be neutralized by holding the right amount of insurance,
diversifying your investments, holding sufficient funds for emergencies, and maintaining different
income streams.
Why Is Financial Risk Important?
Understanding, measuring, and mitigating financial risk is critical for the long-term success of an
organization. Financial risk may prevent a company from successfully accomplishing its finance-related
objectives like paying loans on time, carrying a healthy amount of debt, or delivering goods on time. By
understanding what causes financial risk and putting measures in place to prevent it, a company will
likely experience stronger operating performance and yield better returns.
Is Financial Risk Systematic or Unsystematic?
Financial risk does impact every company. However, financial risk heavily depends on the operations
and capital structure of an organization. Therefore, financial risk is an example of unsystematic risk
because it is specific to each individual company.
The Bottom Line
Financial risk naturally occurs across businesses, markets, governments, and individual finance. These
entities trade the opportunity to make profits and yield gains for the chance that they may lose money
or face detrimental circumstances. These entities can use fundamental, technical, and quantitative
analysis to not only forecast risk but make plans to reduce or mitigate it
6.