Why firms should manage financial risks

Share through Email advertisement If savers and investors and buyers and sellers could locate each other efficiently, purchase any and all assets at no cost, and make their decisions with freely available, perfect information, there would be no need for financial institutions. However, in real economies, market participants seek the services of financial institutions because they can provide market knowledge, transaction efficiency, and contract enforcement.

Why firms should manage financial risks

Subscriber Unlimited digital content, quarterly magazine, free newsletter, entire archive. About the Authors George S. Oldfield is the Richard S.

Santomero is the Richard K. For a full discussion of this issue, see: For a detailed discussion of this literature, see: In fact, a well-known textbook in the field devotes an entire chapter to motivating financial risk management as a value-enhancing strategy using the arguments outlined above.

Why Companies Should Report Financial Risks From Climate Change

Wilford, Managing Financial Risk: This point has been made in a different context. Absent from this list are institutions that are pure information providers, e.

These excluded firms provide important services to the financial sector, but only as third-party vendors. Their credibility is based on reputation, and their product is used by buyers to make better-informed judgments. We distinguish here between the basic financial services offered by financial institutions and the six core functions outlined by Merton and by Merton and Bodie that a financial system provides.

In our view, institutions providing the basic services that we define will create a financial system that provides core functions as defined by Merton. Economic Councilpp. A Functional Perspective Boston: Harvard Business School Press, Commercial banks are a clear example of such institutions.

Therefore, they have devoted considerable energy to interest-rate risk management. To see how this is done, see: Accordingly, lending institutions actively manage their credit portfolios. For a presentation of the techniques used by the banking and insurance industry, respectively, see: Robert Morris Associates, ; and Babbel and Santomero For a discussion of how banks manage counterparty risk, see: For a detailed discussion of this and other mortgage-backed instruments, see: While we focus on REMICs, huge amounts of credit card receivables, auto loans, and other consumer loans are also securitized in similar types of transactions.

An interesting characteristic of REMICs is the use of tranching of the cash flows generated by the underlying assets. Other tranches are more or less generic. Such capital constraints have become increasingly stringent lately due to the multinational Basle accord.

This requires minimum risk-related capital. For a broader discussion, see: North Holland Press,pp. Some equity participation is permitted in different countries around the world. This issue has received substantial attention in the academic literature.

Exactly how this is done is the subject of entire textbooks. For a discussion of techniques employed, see, for example: Saunders, Financial Institutions Management: The ability of fund managers to provide such services has long been debated.

Why firms should manage financial risks

Marcus, Investments Homewood, Illinois:As firms become active participants in new markets and take on new types of financial risks, it is important that appropriate policies and procedures be put into place to measure and manage these risks.

Investors who have real money at risk must understand the exposures facing the firms in which they invest and they must know the extent of risk management at these companies. They also need to be able to distinguish between good risk management programs and bad ones.

Risk management jobs are usually considered as financial careers because most of the risks that businesses face are closely tied to the company’s financial standing.


Risk management jobs are available both internally and externally. Financial risks are associated with the financial structure of your business, the transactions your business makes and the financial systems you already have in place.

Why firms should manage financial risks

This means that the processes you have put in place to manage your business risks should be regularly reviewed. Such reviews will identify improvements to the . Financial risk management is the practice of economic value in a firm by using financial instruments to manage exposure to risk: operational risk, There has been some research on the risks firms must consider when operating in many countries.

A risk management plan helps companies identify risk It is important for a business to identify potential risks. When a business is aware of the potential risks that are associated with their business, it is easier to take steps to avoid them.

Why Firms Should Manage Financial Risks? - Free Essay Example