Showing posts with label Business Risks. Show all posts
Showing posts with label Business Risks. Show all posts
HOW DOES FINANCIAL RISK ARISE?
Risk provides the basis for opportunity. The terms risk and exposure have subtle differences in their meaning. Risk refers to the probability of loss, while exposure is the possibility of loss, although they are often used interchangeably. Risk arises as a result of exposure.
Exposure to financial markets affects most organizations, either directly or indirectly.When an organization has financial market exposure, there is a possibility of loss but also an opportunity for gain or profit. Financial market exposure may provide strategic or competitive benefits.
Risk is the likelihood of losses resulting from events such as changes in market prices. Events with a low probability of occurring, but that may result in a high loss, are particularly troublesome because they are often not anticipated. Put another way, risk is the probable variability of returns.
Since it is not always possible or desirable to eliminate risk, understanding it is an important step in determining how to manage it. Identifying exposures and risks forms the basis for an appropriate financial risk management strategy.
Financial risk arises through countless transactions of a financial nature, including sales and purchases, investments and loans, and various other business activities. It can arise as a result of legal transactions, new projects, mergers and acquisitions, debt financing, the energy component of costs, or through the activities of management, stakeholders, competitors, foreign governments, or weather.
When financial prices change dramatically, it can increase costs, reduce revenues, or otherwise adversely impact the profitability of an organization. Financial fluctuations may make it more difficult to plan and budget, price goods and services, and allocate capital.
There are three main sources of financial risk:
1. Financial risks arising from an organization’s exposure to changes in market prices, such as interest rates, exchange rates, and commodity prices
2. Financial risks arising from the actions of, and transactions with, other organizations such as vendors, customers, and counterparties in derivatives transactions
3. Financial risks resulting from internal actions or failures of the organization, particularly people, processes, and systems.
WHAT IS FINANCIAL RISK MANAGEMENT?
BASIC INFORMATION ON FINANCIAL RISK MANAGEMENT
Financial risk management is a process to deal with the uncertainties resulting from financial markets. It involves assessing the financial risks facing an organization and developing management strategies consistent with internal priorities and policies.
Addressing financial risks proactively may provide an organization with a competitive advantage. It also ensures that management, operational staff, stakeholders, and the board of directors are in agreement on key issues of risk.
Managing financial risk necessitates making organizational decisions about risks that are acceptable versus those that are not. The passive strategy of taking no action is the acceptance of all risks by default.
Organizations manage financial risk using a variety of strategies and products. It is important to understand how these products and strategies work to reduce risk within the context of the organization’s risk tolerance and objectives.
Strategies for risk management often involve derivatives. Derivatives are traded widely among financial institutions and on organized exchanges.
The value of derivatives contracts, such as futures, forwards, options, and swaps, is derived from the price of the underlying asset. Derivatives trade on interest rates, exchange rates, commodities, equity and fixed income securities, credit, and even weather.
The products and strategies used by market participants to manage financial risk are the same ones used by speculators to increase leverage and risk. Although it can be argued that widespread use of derivatives increases risk, the existence of derivatives enables those who wish to reduce risk to pass it along to those who seek risk and its associated opportunities.
The ability to estimate the likelihood of a financial loss is highly desirable. However, standard theories of probability often fail in the analysis of financial markets. Risks usually do not exist in isolation, and the interactions of several exposures may have to be considered in developing an understanding of how financial risk arises.
Sometimes, these interactions are difficult to forecast, since they ultimately depend on human behavior. The process of financial risk management is an ongoing one.Strategies need to be implemented and refined as the market and requirements change.
Refinements may reflect changing expectations about market rates, changes to the business environment, or changing international political conditions, for example. In general, the process can be summarized as follows:
• Identify and prioritize key financial risks.
• Determine an appropriate level of risk tolerance.
• Implement risk management strategy in accordance with policy.
• Measure, report, monitor, and refine as needed.
Financial risk management is a process to deal with the uncertainties resulting from financial markets. It involves assessing the financial risks facing an organization and developing management strategies consistent with internal priorities and policies.
Addressing financial risks proactively may provide an organization with a competitive advantage. It also ensures that management, operational staff, stakeholders, and the board of directors are in agreement on key issues of risk.
Managing financial risk necessitates making organizational decisions about risks that are acceptable versus those that are not. The passive strategy of taking no action is the acceptance of all risks by default.
Organizations manage financial risk using a variety of strategies and products. It is important to understand how these products and strategies work to reduce risk within the context of the organization’s risk tolerance and objectives.
Strategies for risk management often involve derivatives. Derivatives are traded widely among financial institutions and on organized exchanges.
The value of derivatives contracts, such as futures, forwards, options, and swaps, is derived from the price of the underlying asset. Derivatives trade on interest rates, exchange rates, commodities, equity and fixed income securities, credit, and even weather.
The products and strategies used by market participants to manage financial risk are the same ones used by speculators to increase leverage and risk. Although it can be argued that widespread use of derivatives increases risk, the existence of derivatives enables those who wish to reduce risk to pass it along to those who seek risk and its associated opportunities.
The ability to estimate the likelihood of a financial loss is highly desirable. However, standard theories of probability often fail in the analysis of financial markets. Risks usually do not exist in isolation, and the interactions of several exposures may have to be considered in developing an understanding of how financial risk arises.
Sometimes, these interactions are difficult to forecast, since they ultimately depend on human behavior. The process of financial risk management is an ongoing one.Strategies need to be implemented and refined as the market and requirements change.
Refinements may reflect changing expectations about market rates, changes to the business environment, or changing international political conditions, for example. In general, the process can be summarized as follows:
• Identify and prioritize key financial risks.
• Determine an appropriate level of risk tolerance.
• Implement risk management strategy in accordance with policy.
• Measure, report, monitor, and refine as needed.
A Low-Cost, Low-Risk Lease and Option Strategy That Makes Financial Sense
I hope that you heed my advice and avoid using the high-risk sublease-option strategy, which I have written about here. Instead, use a low-risk lease and option strategy, which involves buying a low-cost real estate option on an undervalued single-family house that you can lease at a below-market rental rate.
This way, you not only save money on housing costs but also have the opportunity to profit from the property’s appreciation in value.
The lease and option strategy provides a relatively low-cost, low-risk way to gain control of an undervalued single-family house, without having to incur the cost and financial liability that goes along with outright ownership.
And best of all, when you use the lease and option strategy that I am writing about here, you do not have to become a landlord and babysit tenant-buyers. All you have to do is move in and market the house to potential buyers.
In the meantime, you get all of the benefits of homeownership— less the tax benefits—without ever having to:
1. Qualif y for a loan.
2. Pay a down payment.
3. Pay closing costs.
4. Pay for repairs.
5. Buy any property.
BUSINESS RISK AND FINANCIAL RISK PREMIUM BASICS AND TUTORIALS
BUSINESS RISK AND FINANCIAL RISK PREMIUM BASIC INFORMATION
What Are Business and Financial Risks Premium?
A risk-free investment was defined as one for which the investor is certain of the amount and timing of the expected returns. The returns from most investments do not fit this pattern.
An investor typically is not completely certain of the income to be received or when it will be received. Investments can range in uncertainty from basically risk-free securities, such as T-bills, to highly speculative investments, such as the common stock of small companies engaged in high-risk enterprises.
Most investors require higher rates of return on investments if they perceive that there is any uncertainty about the expected rate of return. This increase in the required rate of return over the NRFR is the risk premium (RP). Although the required risk premium represents a composite of all uncertainty, it is possible to consider several fundamental sources of uncertainty
Business risk is the uncertainty of income flows caused by the nature of a firm’s business. The less certain the income flows of the firm, the less certain the income flows to the investor.
Therefore, the investor will demand a risk premium that is based on the uncertainty caused by the basic business of the firm.
As an example, a retail food company would typically experience stable sales and earnings growth over time and would have low business risk compared to a firm in the auto industry, where sales and earnings fluctuate substantially over the business cycle, implying high business risk.
Financial risk is the uncertainty introduced by the method by which the firm finances its investments. If a firm uses only common stock to finance investments, it incurs only business risk.
If a firm borrows money to finance investments, it must pay fixed financing charges (in the form of interest to creditors) prior to providing income to the common stockholders, so the uncertainty of returns to the equity investor increases.
This increase in uncertainty because of fixed-cost financing is called financial risk or financial leverage and causes an increase in the stock’s risk premium.
What Are Business and Financial Risks Premium?
A risk-free investment was defined as one for which the investor is certain of the amount and timing of the expected returns. The returns from most investments do not fit this pattern.
An investor typically is not completely certain of the income to be received or when it will be received. Investments can range in uncertainty from basically risk-free securities, such as T-bills, to highly speculative investments, such as the common stock of small companies engaged in high-risk enterprises.
Most investors require higher rates of return on investments if they perceive that there is any uncertainty about the expected rate of return. This increase in the required rate of return over the NRFR is the risk premium (RP). Although the required risk premium represents a composite of all uncertainty, it is possible to consider several fundamental sources of uncertainty
Business risk is the uncertainty of income flows caused by the nature of a firm’s business. The less certain the income flows of the firm, the less certain the income flows to the investor.
Therefore, the investor will demand a risk premium that is based on the uncertainty caused by the basic business of the firm.
As an example, a retail food company would typically experience stable sales and earnings growth over time and would have low business risk compared to a firm in the auto industry, where sales and earnings fluctuate substantially over the business cycle, implying high business risk.
Financial risk is the uncertainty introduced by the method by which the firm finances its investments. If a firm uses only common stock to finance investments, it incurs only business risk.
If a firm borrows money to finance investments, it must pay fixed financing charges (in the form of interest to creditors) prior to providing income to the common stockholders, so the uncertainty of returns to the equity investor increases.
This increase in uncertainty because of fixed-cost financing is called financial risk or financial leverage and causes an increase in the stock’s risk premium.
Subscribe to:
Posts (Atom)