Financial risk management is the practice of protecting economic value in a firm by using financial instruments to manage exposure to risk: operational risk, credit risk and market risk, foreign exchange risk, shape risk, volatility risk, liquidity risk, inflation risk, business risk, legal risk, reputational risk, sector risk etc. Similar to general risk management, financial risk management requires identifying its sources, measuring it, and plans to address them. Financial risk management can be qualitative and quantitative. As a specialization of risk management, financial risk management focuses on when and how to hedge using financial instruments to manage costly exposures to risk.

1. BY
VEDANSH BOKOLIA (2K18/BBA/114)

2. Introduction
Financial risk management is the practice of protecting economic value in a firm by
using financial instruments to manage exposure to risk: operational risk, credit risk and market
risk, foreign exchange risk, shape risk, volatility risk, liquidity risk, inflation risk, business
risk, legal risk, reputational risk, sector risk etc. Similar to general risk management, financial
risk management requires identifying its sources, measuring it, and plans to address them.
Financial risk management can be qualitative and quantitative. As a specialization
of risk management, financial risk management focuses on when and how to hedge using
financial instruments to manage costly exposures to risk.

3. Objectives
The objective of market risk management is to reduce the unfavorable effects of changes in
market risk factors on the cash flows and financial results. Market risk management is
conducted using derivative instruments which are used solely to reduce the risk of changes in
fair value and risk of changes in cash flows.

4. Prospective Plans
• Risk Identification, Analysis and Management
• Dealing with Nature and Sources Of Financial Risk
• Discussing Different types of Financial risk
• Benefits of Financial Risk Management
• Steps in the Risk Management Process
• Factors that affect Financial Rates and Prices
• Factors that affect Foreign Exchanges Rates

5. Risk Identification
• Risk identification is the process of determining risks that could potentially prevent the program,
enterprise, or investment from achieving its objectives. It includes documenting and communicating
the concern.
• Risk identification should begin early in the project when uncertainty and risk exposure is
greatest. Identifying risks early allows risk owners to take action when the risks are easier to
address. Risk owners who execute early responses often reduce cost as compared to
addressing risks and issues later in the project.
• Risk identification allows you to create a comprehensive understanding that can be leveraged to
influence stakeholders and create better project decisions. Good risk identification creates good
project communication and good communication creates good decisions.

6. Risk Analysis
• Risk Analysis is a process that helps you identify and manage potential problems that could
undermine key business initiatives or projects. To carry out a Risk Analysis, you must
first identify the possible threats that you face, and then estimate the likelihood that these threats
will materialize.
• To carry out a Risk Analysis, you must first identify the possible threats that you face, and then
estimate the likelihood that these threats will materialize.
• Risk Analysis can be complex, as you'll need to draw on detailed information such as project plans,
financial data, security protocols, marketing forecasts, and other relevant information. However, it's
an essential planning tool, and one that could save time, money, and reputations.

7. Steps in Risk Analysis
• Identify the hazards
• Decide who might be harmed and how
• Evaluate the risks and decide on precautions
• Record your findings and implement them
• Review your risk assessment and update if necessary

8. Nature and scope of Risk
In finance, risk refers to the degree of uncertainty and/or potential financial loss inherent in an
investment decision. In general, as investment risks rise, investors seek higher returns to
compensate themselves for taking such risks. Every saving and investment product has
different risks and returns.

9. Types of Risk
• Market Risk: This type of risk arises due to the movement in prices of financial instrument. Market
risk can be classified as Directional Risk and Non-Directional Risk. Directional risk is caused due to
movement in stock price, interest rates and more. Non-Directional risk, on the other hand, can be
volatility risks.
• Credit Risk: This type of risk arises when one fails to fulfill their obligations towards their
counterparties. Credit risk can be classified into Sovereign Risk and Settlement Risk. Sovereign risk
usually arises due to difficult foreign exchange policies. Settlement risk, on the other hand, arises
when one party makes the payment while the other party fails to fulfill the obligations.

10. • Liquidity Risk: This type of risk arises out of an inability to execute transactions. Liquidity risk can be
classified into Asset Liquidity Risk and Funding Liquidity Risk. Asset Liquidity risk arises either due to
insufficient buyers or insufficient sellers against sell orders and buys orders respectively.
• Operational Risk: This type of risk arises out of operational failures such as mismanagement or
technical failures. Operational risk can be classified into Fraud Risk and Model Risk. Fraud risk arises
due to the lack of controls and Model risk arises due to incorrect model application.
• Legal Risk: This type of financial risk arises out of legal constraints such as lawsuits. Whenever a
company needs to face financial losses out of legal proceedings, it is a legal risk.

11. Benefits of financial risk management
• Reducing Information Asymmetries.
• Reducing Bankruptcy Costs
• Reducing Taxable Income Volatility
• Reducing Weighted Average Costs of Capital
• Reduce Diversifiable Risk
• Improve Management Incentives
• Reducing Probability of Debt overhang

12. Steps in Risk Management Process
• Identity the Risk : The first step is to identify the risks that the business is exposed to in its
operating environment. There are many different types of risks – legal risks, environmental risks,
market risks, regulatory risks, and much more. It is important to identify as many of these risk factors
as possible. In a manual environment, these risks are noted down manually. If the organization has a
risk management solution employed all this information is inserted directly into the system. The
advantage of this approach is that these risks are now visible to every stakeholder in the organization
with access to the system.
• Analyze the Risk : Once a risk has been identified it needs to be analyzed. The scope of the risk must
be determined. It is also important to understand the link between the risk and different factors
within the organization. When a risk management solution is implemented one of the most
important basic steps is to map risks to different documents, policies, procedures, and business
processes.

13. • Evaluate or Rank the Risk : Risks need to be ranked and prioritized. Most risk management solutions
have different categories of risks, depending on the severity of the risk. A risk that may cause some
inconvenience is rated lowly, risks that can result in catastrophic loss are rated the highest. It is
important to rank risks because it allows the organization to gain a holistic view of the risk exposure
of the whole organization.
• Treat the Risk : Every risk needs to be eliminated or contained as much as possible. This is done by
connecting with the experts of the field to which the risk belongs. In a risk management solution, all
the relevant stakeholders can be sent notifications from within the system. The discussion regarding
the risk and its possible solution can take place from within the system. Upper management can also
keep a close eye on the solutions being suggested and the progress being made within the system.
• Monitor and Review the Risk : Not all risks can be eliminated – some risks are always present.
Market risks and environmental risks are just two examples of risks that always need to be
monitored. Under manual systems monitoring happens through diligent employees. These
professionals must make sure that they keep a close watch on all risk factors. Under a digital
environment, the risk management system monitors the entire risk framework of the organization.

14. Factors that that influence interest rate in
an economy
• Demand for money: In a growing economy, money is in demand. Manufacturing sector companies
and industries need to borrow money for their short-term and long-term needs to invest in
production activities. Citizens need money as they need to borrow for their homes, buy new cars, and
other needs. But when an economy isn’t doing that well, companies avoid borrowing if the demand
for their products is low. A very high inventory is detrimental, so they produce less. In effect, they
borrow less, ergo less demand for money. Consumers also spend less as a bad economy could result
in job loss. Other things remaining the same, higher the demand for money higher the interest rates.
• Supply of money : If the supply of money increases, other things remaining the same the price of
money—interest rates, go down. There are situations wherein the investors do not have attractive
avenues and they chase the bonds or deposits. If there is no demand for that money at that moment,
then the interest rates go down. In recessionary times the interest rates tend to go down.

15. • Fiscal deficit and government borrowing: Fiscal deficit is a result of government expenditure
exceeding government revenue. To fund this deficit, the government resorts to borrowing. Being the
largest borrower in the economy, the quantum of government borrowing influences the demand for
money and in turn sways interest rates. Higher the fiscal deficit, higher the government borrowing,
higher the interest rates.
• Inflation: Prices of all goods and commodities are set by taking into account the general price increase
in the economy—inflation. Savers need to be compensated by way of higher interest rates for
sacrificing their current consumption motives in a high inflationary scenario. The real rate of return is
arrived at by deducting inflation number from the nominal rate of return offered on the bonds and
deposits. The ideas to keep the real rate of return positive so that after inflation the saver saves
something.
• Global interest rates and foreign exchange rates: Integration of Indian economy with the global
economy has risen compared to what it was prior to acceptance of globalization in 1991. That means
the interest rates in the economy must be set in line with global trends in interest rates. If India wants
to attract global capital then the interest rates in India need to go up if the interest rates are going up
globally. There are occasions such as the Lehman Crisis in 2008 when the central bankers across the
globe choose to cut interest rates to pull the global economy out of recession.

16. • Central bank: Reserve Bank of India chooses to focus on various objectives while preparing its
monetary policy. In a boom phase, the central bank may focus to contain inflation and hence may
choose to hike interest rates. That curtails the consumption and investments driven by borrowed
money. In a recessionary period, the central bank may want to induce growth by incentivising
consumption and investments by reducing the interest rates

17. Factors that affect Foreign Rates
• Monetary policy and economic performance : If a country has a history of strong economic
performance and sound monetary policy, investors are more inclined to seek out those countries.
This inevitably increases the demand and value of the country’s currency. A recession may also cause
a depreciation in the exchange rate because interest rates usually fall, however, this isn’t always the
case. Other recession factors that can influence currency value include the determent of foreign
investment, which would decrease the value. However, if a recession causes inflation to fall, this
helps a country become more globally competitive and demand for the currency becomes greater.
• Import and export value : A country’s balance of payments (BOP) summarizes all international trade
and financial transactions made by individuals, companies and government bodies complete with
those bodies of that country. These transactions can consist of imports and exports of goods, services
and capital. The reason BOP is included here is that it influences the ratio comparing export prices to
import prices. If the price of a country’s exports are greater than their imports, its ‘terms of trade’
have improved. This creates a greater demand for that country’s exports, and in-turn, greater
demand for the currency.

18. • Geopolitical stability : The political state of a country, coupled with economic performance, can also
affect the strength of the currency. A country with less risk for political turmoil will be more attractive
to foreign investors, leading to an appreciation of the value of its domestic currency from foreign
capital. ‘Geopolitical risk’ is the risk posed to foreign investors by unexpected political developments.
If a country’s economy and political landscape remains predictable, investors are more likely to buy
the currency. The opposite effect is also true, unexpected events lead investors to pull their money
back, sending the currency down in value.
• Inflation rates : Inflation rates impact a country’s currency value. A low inflation rate typically
exhibits a rising currency value, as its purchasing power increases relative to other currencies.
Conversely, those with higher inflation typically see depreciation in their currencies compared to that
of their trading partners, and it’s also typically accompanied by higher interest rates.
• Interest rates : Exchange rates, interest rates and inflation rates are all interconnected. An increase in
interest rates cause a country’s currency to appreciate, as lenders are provided with higher rates and
thereby attracting more foreign capital. This can cause a rise in the value of a currency and therefore
the exchange rate. Cutting interest rates, on the other hand, can lead to a depreciation of the
currency.

19. Thank You