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FINANCIAL
RISK
MANAGEMENT
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INTRODUCTION
DEFINITION
y The process of evaluating and managing current and
possible financial risk at a firm as a method of decreasing
the firm's exposure to the risk.
y Focuses on when and how to hedge using financialinstruments to manage costly exposures to risk.
WHEN TO USE FINANCIAL RISK MANAGEMENT
y Risk which shareholders cannot take
y Unique risks- Best CandidatesWHY TAKE RISKS?
Dividend or interest
Build a diversified Portfolio
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WHAT IS RISK &
TYPES OF RISK
DEFINITION
y Chance that an investment's actual return
will be different than expected.
TYPES OF FINANCIAL RISK
y Credit risk
E.g..: The bankruptcy of a counterparty
y Liquidity risk
E.g..: A temporary inability to convert assets
to cash
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y Systemic risk
If Mr. A defaults then there arrises systemic risk
y Unsystematic Risk
E.g..: News that affects a specific stock such as a
sudden strike by employees.
y Operational risk
E.g.: The HR department takes care of personnel
risks
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y Identify The Risk Lists of possible risk sources
Risks are then categorized and prioritized
y Assess the risk
Identify The Root Causes
What would cause this risk?
How will this risk impact the project?
y Develop Responses To The Risk
Project team is ready to manage /prevent the risk
y Develop Preventative Measures
Convert into tasks those ideas that were identified
THE RISK ANALYSIS
PROCESS
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STRATEGIES
y Transferring the risk to another party
For Example:
Mr. A Insurance company
y Avoiding the risk:
y Reducing the negative effect & accepting some or
all of the consequences of a particular risk
y Ideal Risk Management
y Intangible risk management
y Faces difficulties allocating resources
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RISK FROMVARIOUS
PERSPECTIVES
RISK FROMVARIOUS
PERSPECTIVES
RISK TOINVESTORS
RISK TOINVESTORS
RISK TO ANINSURANCECOMPANY
RISK TO ANINSURANCECOMPANY
RISK TOCOMPANYRISK TO
COMPANY
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MANAGING RISK BY INVESTORS
DETERMING RISK OF AN ASSET
STOCKS
BONDS
CASH
SELECTINGRISK
AGE
FINANCIALRESPONSIBILITIES
EVALUATNG SPECIFICINVESTME
T
BUYING
SELLING
Dont put all eggs in one basket
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RISK EXPOSURE TO INVESTORS
When you invest, you take certain risks.
But how do you figure out ahead of time what
those risks might be?
Which ones you are willing to take?
Which ones may never be worth taking?
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RISK FACED BY INVESTORS
Inflation risk
Translation risk
Maturity Risk
Sociopolitical risk
Liquidity risk
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DIVERSIFYING YOUR PORTFOLIO
INVESTMENTPORTFOLIO OF
Mr. B
MUTUALFUNDS
&BONDS
MUTUALFUNDS
&BONDS
REALESTATE
REALESTATE
SHARESSHARES
INVESTMENTPORTFOLIO OF
Mr. A
SHARESSHARES
CASH
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Say, If Mr. A has invested only in Shares & again
he had invested all his shares in XYZ Co. IfShares of XYZ Co. fall then
INVESTMENTPORTFOLIO OF
Mr. A
NO
INCOMEFROMSHARES
NO
INCOMEFROMSHARES
INVESTMENTPORTFOLIO OF
Mr. B
MUTUALFUNDS
&BONDS
MUTUALFUNDS
&BONDS
STOCKS& REALESTATE
STOCKS& REALESTATE
SHARES
SHARES
CASH
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THE RISK-REWARD
TRADEOFF
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RISK MANAGEMENT
BY
INVESTORS
Mr.A- Fixed Rate
(8%)
Mr. B- Floating Rate
Assumption:
1.Opposite Views
2.You are Mr.A
MR.BBELIEVES
INTERESTRATE TO
MR.A
BELIEVESINTERESTRATE TO
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XYZ BankLtd.
Mr. A
Mr. B
# Change of
interest rate
- Fixed to
floating
#Change of
interest rate-
floating into fixed
rate (8.5%)
INTEREST RATE SWAP
SCENARIO 1
Interest rate to 9.5%
Mr.A gets 9.5% ROI&
Mr. B gets 8.5% ROI
SCENARIO 2
Interest rate to 6%
Mr.A gets 6% ROI&
Mr. B still gets 8.5%
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FINANCIAL RISKS MANAGEMENT BY
INSURANCE COMPANIES
The role of insurers in the financial sector.
Risks contained in the insurers product are not
all borne directly by the insurer itself.
It should accept only those risks that areuniquely a part of the insurers array of services.
Catastrophe risk can be offset somewhat by
undertaking a position in catastrophe futures
and perhaps even in catastrophe bonds.
They can offer products which absorb some
financial risks, while transferring some of these
risks to the purchaser.
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STRATEGIESBY
INSURANCECOMPANIES
STRATEGIESBY
INSURANCECOMPANIES
REINSURANCEREINSURANCE RISKPOOLRISKPOOL
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REINSURANCE
XYZ LTD. has insured its industry against fire with Bajaj Allianz
for Rs.20 crore
Bajaj Allianz feels that the risk is huge
Re-insurance to transfer/spread risk
Finally, risk of 20 crore is divided as follows:
NEW INDIAASSURANCE
RISK-5cr
BAJAJALLIANZ
RISK- 4 cr
ICICILOMBARD
RISK3 cr
NATIONALINSURANCE
RISK- 3 crORIENTAL
RISK- 5 cr
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TERRORISMPOOL
ROYALSUNDARAM
ICICILOMBARD
NEW INDIAASSURANCE
BAJAJALLIANZ
NATIONAL
INSURANCE
COMPANY
OTHER
FOREIGN
COUNTRIES
INSURANCE
COMPANIES
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CASE STUDY- TAJHOTEL
Terrorism is one of the catastrophe risks
that is covered under risk pool
An add-on with property insurance
The trident complex has a total insurance
cover ofRs1,430 crore
Personal accidents and individual deaths
Hotels have their separate liability policies
Leading insurer -Tata AIG general
insurance co.
Co-insurers -ICICI Lombard general
insurance co. LtdIFFCO Tokio general
insurance co. Ltd.
Terrorism claims are settled from a
common pool managed by the state-run
general insurance corporation.
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RISK DIVERSIFICATION BY COMPANY
Specialization by diversification
A company should diversify its knowledge areaand highly concentrate in its products and
market area.
Management risk also known as company risk
For example Reliance industry
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RELIANCE INDUSTRY PRIVATE LIMITED
RelianceIndustry
Power Insurance
Retailsector
Mutualfunds
Infrastructue
Communication
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Risk controls measure Diversification
The principal ideas is that if any Reliance sector
goes devalue,other Reliance sectors will cop up
with it.
Diversification also helps in getting profitability
to company
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CONCLUSION
Financial risk management is one of the core
components of financial management study.
Financial Risk management help you reach aserious managerial position, it also makes you
deal with money better.
It has become a common practise in financialinstitutions protect against the adverse effects of
uncertainty