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How Companies Use Risk Management to Identify, Measure & Manage Risks

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How Companies Use Risk Management to Identify, Measure & Manage Risks

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Treasury management ranks at the top in the long and complex list of managing risks by corporate treasuries. The risks differ in terms of the geographic and business environment in which the corporation operates, with specific reference to financial risks such as interest rates, foreign exchange, commodity risks, and credit and liquidity risks. A key risk which treasuries will have to deal with is the counterparty risk or when there is default by the counterparty and contractual obligations are not fulfilled. The diverse type of risks demands that solutions have to be built to overcome every eventuality.

With reference to management techniques for treasury risks, the requirement is to explore the real-time situation in overcoming or adopting course correction to limit the impact of these risks on the organization. The issue is more likely with reference to events which may have a positive or negative impact on the financial performance of an organization. Typically the treasury risks faced by these organizations are – foreign currency risks, interest rate risks, commodity risks and counterparty risks.

The best way for management techniques for treasury risks such as foreign exchange is to focus on the banks and research their currency regulations for advice. The second risk is Interest rate risk and will give rise to companies which are exposed to risk in terms of interest rates. The company will when borrowing or extends credit is likely to suffer from such a condition. The issue could get compounded when it also suffers from floating-rate debt. The increase in the interest rate will significantly impact the interest expense in the outstanding debt relation.

Another interesting issue is the ‘yield-curve risk.’ Banks have interest-rate based securities in the bonds and are likely to be sensitive to changes that yield curve. Term structure of interest rates and will use a basic graph which will plot yields for comparable bonds in terms of maturities.

Treasury risks also include bonds portfolio which has different maturities with the calculation of portfolio duration and the basis point, or how basis point change in yield influences the value of a portfolio. The duration for measuring interest rate sensitivity for fixed income portfolio managers for the parallel shift in the yield curve. The other type of risk management is that of commodity risk. Here the challenges arise from fluctuations in prices of oil, sugar, agriculture as well as metal. Such price changes may be the result of changes in tax regimes, market impact, political changes as well as commodity prices.

Thus the emerging characteristic of management techniques for treasury risks is that they will ensure the immediate challenges that occur from finance-related issues impact is minimized with respect to these commodities. Foreign currency risks are the most common of the challenges before multinational companies as they are involved in buying and selling of different currency products in different countries. The foreign exchange risks are the highest exposure for such companies. The reason for such risks is due to the real-time foreign currency transactions which occur when purchasing or paying dividends, capital injections and physical transfers for foreign currencies.

Andy McGowan
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