Many companies use the insights of financial managers and external consultants to manage their risk. A one-size-fits-all solution is not yet in existence when it comes to risk management.
These companies usually use derivatives like forwards, options, swaps and futures to offset their risk, but without a clear set of risk-management goals, the use of derivatives can increase the risk substantially.
Top-level managers and financial engineers must work in tandem to develop and execute a strong risk-management strategy. The three basic premises for this corporate strategy are:
The single goal for this strategy is to have enough cash available to make value-boosting investments.
Future markets are nothing new, and before the stock market, they existed in many places in the form of crop trade, back in the middle ages.
Farmers would hedge their risks by selling their crops to consumers at preset prices on a predetermined future date. This provided assurance to a risk-averse farmer that his crop price would not fluctuate in the future.
Corporations managing risk themselves face a fundamental question: why do they need to do it? Individuals and investment groups can manage the risk on their own. Making good investments seems like a better option.
Hedging bets are mostly fictional transactions that don’t affect the value of any operating asset of the company, making it a loss-making proposition if the transaction costs and other overheads are added up.
Risk management through hedging allows companies to borrow from themselves, transferring funds to where they are needed the most.
Top leaders and managers can benefit from these broad guidelines on risk-management issues: