Pros and Cons of Risk Management Essay

1.0 The pros of risk managementMaintaining battleAdverse changes in interest and exchange scores may mortify the competitive position of a company against those with lower levels of gearing or smaller exchange rate exposures, or compared with companies that have taken the guardianship of hedging against rate changes.Reduction of bankruptcy riskAdverse movements in interest and exchange rates may jeopardize the continued outgrowth of a company. A classic example is that of a highly adapt company with a large proportion of floating rate debt cosmos forced into bankruptcy due to an sum up in interest rate.Restructuring of dandy obligationsInterest rate hedging instruments cigarette be used to restructure a companys capital profile by fastening the temperament of its interest obligations, thereby avoiding the repayment of existing debt or the payoff of new securities. In consequence, considerable savings stinker be do in respect of call fees and issue costs. At the same ti me, a wider range of financial sources becomes available to the company.Reducing in the volatility of embodied cash flowsReducing the volatility of net cash flows may increase the market rating of the company and will facilitate the process of forrard planning.2.0 The cons of risk managementThe complicated nature of hedging instrumentsA compounding of unfamiliarity with the range of hedging methods available and a belief by potential users that such methods are complex may result in treasurers choosing not to hedge exchange and interest rate exposures.The risks associated with using extraneous hedging instrumentsThe perceived risk associated with in using hedging instruments can sometimes dissuade potential users. Instead of providing protection from steeply change magnitude interest rates, the transactions turned out to be highly regretful bets.The complicated tax and financial reporting handlings of derivativesThe accounting and tax treatment of derivatives has tended to lag b ehind the pace of their development owing to the dynamic nature of their markets. The major problem regarding the accounting treatment of derivatives is kat onceing exactly what instruction to disclose and how to disclose it.Diversification by shareholders may be supreme to hedgingAn alternative to hedging by individual companies is for shareholders to diversify remote interest and exchange rate risk themselves by holding a diversified portfolio of shares, hence saving the costs associated with hedging at a corporate level. If shareholders hold diversified portfolios, some commentators argue that hedging of exposures by individual companies is motivated purely by managements intrust to safeguard their jobs, rather than a desire to enhance shareholder wealth.3.0 endingAs a conclusion, exchange rate risk and interest rate risk can be managed by the use of both internecine and external techniques. Internal techniques allow companies to hedge risk within their deliver balance she et by the way in which they structure their assets and liabilities. Alternatively, companies can employ one or more of the many external techniques now available, such as swaps, options, futures and forwards. While these derivative instruments give more range and flexibility to companies to manage their risk, their associated costs and their complicated nature must be taken into account.