Risk Management and Financial Risks

Paper Summary:

This paper explains how financial managers use financial derivatives to help them determine risks accurately and better control them. The paper explains the role financial derivatives play in this aspect of financial management and the different types of financial derivatives available. The paper also discusses the importance of understanding the intended function of derivatives and that the users of this tool take necessary precautions before using it. The paper also looks at the types of financial institutions involved with financial derivatives, explains how certain types can help financial managers hedge financial risk, and looks at the reasons for the growth in the market of financial derivatives.

Introduction
Roles of Financial Derivatives
Futures and Options Can Help Risk Managers to Hedge Financial Risk

From the Paper:

"One of the first uses of financial derivatives was to reduce exposure to changes in rates of foreign exchange, interests, or stock market valuation. As an example take the situation of an American company has sent goods for which they will be paid in British Pounds. It has the choice or "option" of entering into a derivative contract with another party to reduce the risk of British Pound increasing in value compared to US Dollar when the payment is made. Through the use of the instrument, the party covering the risk is compelled to pay the exporter the value in American Dollars at the rate at which the instrument was finalized. Thus the derivative has shifted the exchange risk from the exporter to another party. These instruments are continually gaining in popularity and familiarity, and this increase in popularity is also increasing the variety of such instruments that are now available. One has to understand the latest uses of derivatives and the implications of the concerned transactions to get the benefit from these instruments."

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