Pros and Cons of Risk Management Essay

1.0 The pros of risk oversightMaintaining competitivenessAdverse changes in pursual and shift runs may reduce the competitive site of a club against those with lower levels of gearing or smaller trade position exposures, or compared with companies that have taken the precaution of hedging against rate changes.Reduction of failure riskAdverse movements in interest and modify rates may jeopardize the continued operation of a company. A classic example is that of a highly geared company with a large proportion of floating rate debt being forced into bankruptcy due to an increase in interest rate.Restructuring of capital obligationsInterest rate hedging instruments offer be used to restructure a companys capital profile by altering the nature of its interest obligations, thereby avoiding the repayment of existing debt or the issuing of new securities. In consequence, considerable savings can be made in wonder of call fees and issue costs. At the same time, a wider avow of fi nancial sources becomes available to the company. step-down in the volatility of corporate cash flowsReducing the volatility of net cash flows may increase the market range of the company and will facilitate the process of forward planning.2.0 The cons of risk governmentThe complicated nature of hedging instrumentsA combination of unfamiliarity with the range of hedging methods available and a belief by potential users that such methods are complex may result in treasurers choosing not to hem in exchange and interest rate exposures.The risks associated with using external hedging instrumentsThe perceived risk associated with in using hedging instruments can sometimes deter potential users. Instead of providing protection from steeply increasing interest rates, the proceeding turned out to be highly speculative bets.The complicated measure and financial reporting treatments of derivativesThe accounting and tax treatment of derivatives has tended to lag layabout the pace of thei r development owing to the dynamic nature of their markets. The major difficulty regarding the accounting treatment of derivatives is knowing exactly what information to unwrap and how to disclose it.Diversification by share fighters may be superior to hedgingAn alternative to hedging by individual companies is for shareholders to diversify away interest and exchange rate risk themselves by holding a diversified portfolio of shares, thusly saving the costs associated with hedging at a corporate level. If shareholders hold diversified portfolios, some commentators argue that hedging of exposures by individual companies is do purely by managements desire to safeguard their jobs, so acer than a desire to enhance shareholder wealth.3.0 ConclusionAs a conclusion, exchange rate risk and interest rate risk can be managed by the use of both internal and external techniques. internecine techniques allow companies to hedge risk within their own balance tatter by the way in which they st ructure their assets and liabilities. Alternatively, companies can employ one or more of the many external techniques now available, such as swaps, options, futures and forwards. While these derivative instruments give more scope and flexibility to companies to manage their risk, their associated costs and their complicated nature must be taken into account.