Risk Management/Finance

Risk Management in Finance

Risk Management has become a major focus for financial managers during recent years. The driver is an optimization process

• to minimize financial loss (negative statement)
• to maximize the revenue of a company.

The risk that a firm faces is often assessed in terms of exposure. The exposure that a firm experiences is a quantified representation of the value change it will experience whenever an underlying parameter changes. The primary underlying parameters that must be addressed include commodity prices, interest rates, and exchange rates. Given that the firm's value change with respect to a change in one of these underlying parameters is important it is apparent that risk management often relies upon the interpretation of the relevant partial derivatives. For example the first partial derivative of the firm's value with respect to an underlying commodity price. Similarly, it may be important to know the first partial derivative of the firm's value with respect to an interest rate. Furthermore, the first partial derivative of the firm's value with respect to an exchange rate could be important for firms that are somehow exposed to international markets.

When we think of risk in a business sense, there are a multitude of examples that come to mind. As a business or investor anticipates making a financial decision, the question of risk as it pertains to possible reward must be considered. We can measure this in many ways, but in its most basic form are we getting enough back in return for the risk being taken? While we would like to believe there are low risk/high return relationships in business, the fact is that this is indeed rare. As we dig deeper into the example risk, we find occurrences of low risk/high return and high risk/low return eventually regress to the mean of x risk/x return. There may be inherent risk in aspects of business such as entrepreneurship.

Learning Task

• Explore the concept of resilience and explain, what are interventions, management activities that improve resilience in finance.
• If we describe resilience in the finance system as the capacity of an to respond to a disturbance by preventing damage and recovering quickly from a crisis, you might know measures that increase or decrease the resilience.
• Were these measures part of your financial risk management strategies? What are your individual consequences and needs for the finance system, you know about?