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Financial risk

Introduction

1.1 Definition of financial risk

 'A risk of a change in a financial condition such as an exchange rate,
interest rate, credit rating of a customer, or price of a good'.

1.2 To hedge or not?

Benefits of hedging Arguments against hedging

 Can provide certainty of cash  May harm interest of shareholders
flows with diversified portfolios

 Risk will be reduced  Significant transaction costs

 Reduction in probability of financial  Lack of expertise within the
collapse business

 May be perceived to be a more  Complexity of accounting and tax
attractive employer to risk-averse issues
managers
 For some risks, gains and losses
 May reduce taxes may cancel out in the long run.

1.3 Derivatives

 A derivative is a financial instrument whose value depends on the price of some
other financial asset or underlying factor (such as oil, gold, interest rates or
currencies).

 Derivatives can be used for hedging, speculation and/or arbitrage.

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