Derivatives And Risk Management Essay Example | Topics and Well Written Essays - 2750 words

Derivatives And Risk Management - Essay ExampleRisk direction is the process of identifying, understanding, analysing, accepting, or mitigating jeopardize. Risk management can be divided into two briny processes, find the level of jeopardize exposure in an investment and then handling that risk in the outflank way possible in line with the objectives of the investment (George, 2012, pp.34-38).The risk of fiscal exposure affects all organisations, both(prenominal) directly and indirectly. Though fiscal exposure presents the opportunity for loss, it may also present strategic benefits for devising profits. The fiscal losses of a company arise from three main sources. The first source of risk is a companys exposure to changes in the market prices of commodities (Philippe, 2001, pp.23-25). Second is through actions and transactions of third gear parties such as creditors and counterparties to derivative transactions, and finally are financial risks occurring from the internal fai lures of the organisation, people, or processes. Financial risk arises from countless transactions of a financial nature which an organization engages in such as purchases, investments, and loans repayments. If financial prices rise, there is the possibility that the company makes financial losses (Philippe, 2001, pp.3-6). ... Financial risk management usually involves the custom of derivatives which are traded widely among financial market players. A derivative is a security whose price is derived from one(a) or more other assets. It is just a contract between two parties specifying conditions under which payments result be made in coming(prenominal) between the two parties. Examples of derivatives are options, futures, forwards, and swaps. In the past, diversification was the main way of financial risk management but has now been overrun by the availability of derivatives in most markets which makes it possible for both corporate as well as individual investors to manage risks (Whittaker, 2009, p.19). This stem will analyse the concept of hedging in financial risk management, the best hedging strategies, swaps, and options as they are used in risk management. 2.0 hedgingrow Vs. Speculation The management of risks involves the use of derivatives. Derivatives in financial risk management refer to securities whose value depends on the value of the underlying asset. Among the kinds of derivatives that exist in financial market includes futures, forward contracts, option, and swaps (Smith & Stulz, 2009, pp.267-284). The underlying assets whose values the derivatives depend on are stocks, bonds, interest rate, foreign put back instruments, and even commodities. The respective derivatives for these assets are stock options, interest rates futures, currency futures, bond options, and commodity futures. Hedging is the strategy that is used when managing the risk of the underlying asset using derivatives (Nance, et al, 1993, pp.267-284). In financial markets, a hedge can be referred to as an investment position whose purpose is to offset a potential future