FINANCIAL RISK MANAGEMENT

INTRODUCTION
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DEFINITION The process of evaluating and managing current and possible financial risk at a firm as a method of decreasing the firm's exposure to the risk. Focuses on when and how to hedge using financial instruments to manage costly exposures to risk. WHEN TO USE FINANCIAL RISK MANAGEMENT Risk which shareholders cannot take Unique risks- Best Candidates WHY TAKE RISKS? Dividend or interest Build a diversified Portfolio

WHAT IS RISK & TYPES OF RISK y DEFINITION Chance that an investment's actual return will be different than expected.. TYPES OF FINANCIAL RISK Credit risk E.: A temporary inability to convert assets to cash y y .g.g.: The bankruptcy of a counterparty Liquidity risk E..

.g.g.y Systemic risk y y If Mr. A defaults then there arrises systemic risk Unsystematic Risk E.: News that affects a specific stock such as a sudden strike by employees. Operational risk E.: The HR department takes care of personnel risks .

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THE RISK ANALYSIS PROCESS Identify The Risk Lists of possible risk sources Risks are then categorized and prioritized y Assess the risk Identify The Root Causes What would cause this risk? How will this risk impact the project? y Develop Responses To The Risk Project team is ready to manage /prevent the risk y Develop Preventative Measures Convert into tasks those ideas that were identified y .

A Insurance company Avoiding the risk: y ± y Reducing the negative effect & accepting some or all of the consequences of a particular risk y Ideal Risk Management y Intangible risk management y Faces difficulties allocating resources .STRATEGIES y Transferring the risk to another party For Example: Mr.

.MANAGING DIVERSIFICATION Diversification Risk control sound investment To increase the profitability of the business or an investors portfolio The loss in one sector can be set off with the profitability in other line of sector.

RISK TO INVESTORS RISK FROM VARIOUS PERSPECTIVES RISK TO COMPANY RISK TO AN INSURANCE COMPANY .

MANAGING RISK BY INVESTORS DETERMIN G RISK OF AN ASSET ‡ STOCKS ‡ BONDS ‡ CASH SELECTING RISK ‡ AGE ‡ FINANCIAL RESPONSIBILITIES EVALUATN G SPECIFIC INVESTME T ‡BUYING ‡SELLING ³Don¶t put all eggs in one basket´ .

But how do you figure out ahead of time what those risks might be? Which ones you are willing to take? Which ones may never be worth taking? . you take certain risks.RISK EXPOSURE TO INVESTORS When you invest.

RISK FACED BY INVESTORS Inflation risk Translation risk Maturity Risk Sociopolitical risk Liquidity risk .

DIVERSIFYING YOUR PORTFOLIO CASH SHARES SHARES REAL ESTATE MUTUAL FUNDS & BONDS INVESTMENT PORTFOLIO OF Mr. A INVESTMENT PORTFOLIO OF Mr. B .

Say. A has invested only in Shares & again he had invested all his shares in XYZ Co. If Mr. A ± MUTUAL FUNDS & BONDS INVESTMENT PORTFOLIO OF Mr. B . If Shares of XYZ Co. fall then CASH NO INCOME FROM SHARES SHARES STOCKS & REAL ESTATE ± INVESTMENT PORTFOLIO OF Mr.

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THE RISK-REWARD TRADEOFF .

You are Mr.Floating Rate Assumption: 1.B BELIEVES INTEREST RATE TO MR.A MR.A BELIEVES INTEREST RATE TO . B.Opposite Views 2.RISK MANAGEMENT BY INVESTORS Mr. A.Fixed Rate (8%) Mr.

A gets 6% ROI & Mr.5% ROI & Mr.5% ROI SCENARIO 2 Interest rate to 6% Mr. Mr.5%) SCENARIO 1 Interest rate to 9.INTEREST RATE SWAP Mr. B still gets 8.5% . B # Change of interest rate . B gets 8. A XYZ Bank Ltd.A gets 9.Fixed to floating # Change of interest ratefloating into fixed rate (8.5% Mr.

Catastrophe risk can be offset somewhat by undertaking a position in catastrophe futures and perhaps even in catastrophe bonds. Risks contained in the insurer·s product are not all borne directly by the insurer itself. . while transferring some of these risks to the purchaser. They can offer products which absorb some financial risks.FINANCIAL RISKS MANAGEMENT BY INSURANCE COMPANIES The role of insurers in the financial sector. It should accept only those risks that are uniquely a part of the insurer·s array of services.

STRATEGIES BY INSURANCE COMPANIES REINSURANCE RISK POOL .

4 cr ORIENTAL RISK.5 cr .20 crore Bajaj Allianz feels that the risk is huge Re-insurance to transfer/spread risk Finally. risk of 20 crore is divided as follows: ICICI LOMBARD RISK ²3 cr NATIONAL INSURANCE RISK.REINSURANCE XYZ LTD.3 cr NEW INDIA ASSURANCE RISK-5cr BAJAJ ALLIANZ RISK. has insured its industry against fire with Bajaj Allianz for Rs.

ROYAL SUNDARAM BAJAJ ALLIANZ ICICI LOMBARD TERRORISM POOL NATIONAL INSURANCE COMPANY OTHER FOREIGN COUNTRIES INSURANCE COMPANIES NEW INDIA ASSURANCE .

Terrorism claims are settled from a common pool managed by the state-run general insurance corporation.CASE STUDY. Ltd.430 crore Personal accidents and individual deaths Hotels have their separate liability policies Leading insurer -Tata AIG general insurance co. Co-insurers -ICICI Lombard general insurance co. . Ltd IFFCO Tokio general insurance co.TAJ HOTEL Terrorism is one of the catastrophe risks that is covered under risk pool An add-on with property insurance The trident complex has a total insurance cover of Rs1.

Management risk also known as company risk For example Reliance industry .RISK DIVERSIFICATION BY COMPANY Specialization by diversification A company should diversify its knowledge area and highly concentrate in its products and market area.

³RELIANCE INDUSTRY PRIVATE LIMITED´ Reliance Industry Communication Power Insuranc e Retail sector Mutual funds Infrastructu e .

Risk controls measure Diversification The principal ideas is that if any Reliance sector goes devalue.other Reliance sectors will cop up with it. Diversification also helps in getting profitability to company .

it also makes you deal with money better.CONCLUSION Financial risk management is one of the core components of financial management study. It has become a common practise in financial institutions protect against the adverse effects of uncertainty . Financial Risk management help you reach a serious managerial position.

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