Why Firms Should Manage Financial Risks?

Topics: Risk management, Risk, Value at risk Pages: 12 (3620 words) Published: October 30, 2009
Q) Why firms should manage Financial Risks?

The etymology of the word “RISK” can be traced to the Latin word “RESCUM” meaning danger at sea or that which cuts. Managing business in a highly volatile environment is like navigating a ship on stormy seas. The modern business is confronted with many risk, some of which are basic eg., loss of property due to natural calamities, civil unrests etc., and some are strategic risks. Strategic risks may manifest themselves in several ways like foreign exchange rates or interest rates or commodity prices impacting the expected value or the real cash flow. In recent years, life has become a lot more complicated. Today firms are confronted with business risks that are greater and more varied than ever before. The same technology that has dramatically improved our way of life has also created the potential for disasters some of them like, in 1970s and 1980s, financial and commodity asset prices became quite volatile due to a varity of factors, such as the breakdown of the Bretton woods system of fixed exchange rates, the oil price shocks in 1971 and 1973 because of the excess government spending and inflation policies etc.

Purpose of Risk Management
The purpose of risk management is not necessarily to avoid risk altogether, and complete elimination of risk is not possible. Instead the purpose of risk management is to identify which risk are relevant and in what amount for the smooth functioning of an business or an organization that helps in devising suitable strategies to handle relevant risks

Risk Management concept and Definition

Risk management is one of the specialized functions of general management, as such risk management shares many of the characteristics of general management, and yet is unique in several important respects.

The strategies include transferring the risk to another party, avoiding the risk, reducing the negative effect of the risk, and accepting some or all of the consequences of a particular risk.

One can say a Risk is a situation wherein objective probability distribution of the values a variable can take is known, even though the exact values it would take are not known


The definition of risk depend on specific application and situational contexts and is considered as an indicator of threat and can be assessed qualitatively or quantitatively.

Risk is defined as Risk= (probability of an accident) X (losses per accident)

Risk management is defined as the process of planning, organizing, directing and controlling the resources and activities of an organization in order to minimize the adverse effects of potential losses at the least possible costs.

Risk management is the human activity which integrates recognition of risk, risk assessment, developing strategies to manage it, and mitigation of risk using managerial resources.

Risk management is a concept that denotes a potential negative impact to an asset or some characteristic of value that may arise from some present process or future event, and is often used synonymously with the probability of a unknown loss.

Financial risk
In finance, risk is the probability that an investment’s actual return will be different than expected. This includes the possibility of losing some or all of the original investment. It is usually measured by calculating the standard deviations of the historical returns or average returns of a specific investment.

“A fundamental idea in finance is the relationship between risk and return. The greater the amount of risk that an investor is willing to take on, the greater the potential return. The reason for this is that investors need to be compensated for taking on additional risk”

Financial risk is often defined as the unexpected variability or volatility of returns, and thus includes both potential worse than expected as well as better than expected...
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