Treasury Risk Management PDF

INTEREST RATE HEDGING: -A company with variable-rate loans might use an interest rate swap to exchange its variable interest rate payments for fixed-rate payments. This protects against rising interest rates, ensuring that the company’s interest expenses remain predictable. LIABILITY: -Debts needed...

INTEREST RATE HEDGING: -A company with variable-rate loans might use an interest rate swap to exchange its variable interest rate payments for fixed-rate payments. This protects against rising interest rates, ensuring that the company’s interest expenses remain predictable. LIABILITY: -Debts needed to be paid off, short term or long term. SCENARIO ANALYSIS: -Examining potential future events and their impact through different scenarios. TRANSACTION COSTS: -Hedging often involves transaction costs (e.g., premiums for options), which can reduce overall profitability. STOCKS: -Stocks represent ownership in a company, granting shareholders voting rights and potential dividends. Individuals can invest in stocks through brokerage accounts, either directly or through mutual funds or ETFs. CERTIFICATES OF DEPOSIT (CDs): -CDs are time deposits at a bank that offer a fixed interest rate in exchange for a commitment to keep the funds deposited for a specific term. They provide a higher return than savings accounts but lock up the funds for a set period. -are time deposits offered by banks, thrift institutions, and credit unions. They provide a fixed interest rate in exchange for a commitment to keep the funds deposited for a specific term, typically ranging from a few months to a year. RISK AVOIDANCE: -Avoiding activities or decisions that expose one to a particular risk. -This involves eliminating the risk entirely by avoiding the activity or situation that poses the threat. This is a suitable strategy for high-impact risks that cannot be effectively mitigated. FORWARD CONTRACTS: -Forward contracts are agreements between two parties to buy or sell an asset at a predetermined price on a future date. They are widely used for hedging purposes, particularly in commodities markets. For example, a wheat farmer may enter into a forward contract to sell their crop at a fixed price to eliminate the risk of price fluctuations. MUTUAL FUND: Mutual funds pool money from multiple investors to invest in a diversified portfolio of assets, such as stocks, bonds, or real estate. They offer diversification and professional management, making them a popular choice for individual investors. RISK REDUCTION -This involves taking steps to reduce the likelihood or impact of the risk. This strategy focuses on minimizing the negative consequences of potential threats. -Taking proactive steps to minimize the likelihood of risk events or reduce their impact. RETIREMENT ACCOUNTS: -These accounts, such as 401(k)s and IRAs, allow individuals to save for retirement with tax advantages. They often invest in a variety of assets, including stocks and bonds. RISK MANAGEMENT -One of the primary reasons investors use derivatives is for risk management purposes. Derivatives allow market participants to hedge their positions by protecting against adverse price movements. -Hedging is a risk management strategy used to offset potential losses in an investment or financial position by taking an opposite position in a related asset or financial instrument. FUTURES CONTRACT: - are standardized forward contracts traded on exchanges. They offer greater liquidity and standardization but are less flexible than forward contracts. - In Hedging, FCs are agreements to buy or sell an asset at a future date for a predetermined price. Commonly used for commodities, currencies, and interest rates. - are similar to forward contracts but are traded on organized exchanges. They provide investors with the opportunity to speculate on the future price movements of an underlying asset without owning it physically. Futures contracts offer enhanced liquidity and standardized terms, making them popular among traders and institutional investors. OPTIONS: - Financial derivatives that give the holder the right, but not the obligation, to buy (call) or sell (put) an asset at a specific price within a set time frame. CONTINGENCY FUNDS: - A reserve of money set aside to cover possible unforeseen future expenses. (EMERGENCY FUNDS) - These funds are emergency funds that every companies should have. POLITICAL RISK INSURANCE: - Protecting against losses from political instability or adverse government actions. STRESS TESTING: - Regularly assessing risks and the company’s ability to withstand adverse conditions. - Evaluate the resilience of financial positions against extreme interest rate scenarios. By modeling plausible but extreme scenarios, vulnerabilities can be identified, and contingency plans can be developed. LIQUIDITY (Management) - Excess money that's ready to ensure ability to pay off short term debts. - Maintaining adequate liquidity to ensure the ability to meet short-term obligations. CURRENCY RISK (Foreign exchange risk): - Losses due to changes in the exchange rate between currencies. SWAPS: - Agreements between two parties to exchange cash flows or financial instruments, typically used to manage interest rate or currency risks. - Swaps are agreements between two parties to exchange cash flows based on different variables, such as interest rates or currencies. They are commonly used to manage risks associated with fluctuating interest rates and currency exchange rates.