The Different Types of Financial Risk Management
Every company has its own financial risk management system in order to face the different types of risks and the hazardous situations associated to them. If this strategy is not made and implemented, the company can suffer huge losses. Whether it is the risk associated with frauds from customers or changes in the business environment, the company must make proper risk management strategies to counter it.
Financial risks are usually those related to stocks, commodities, interest rates and bonds; they are also usually faced by multi-national companies, joint stock companies or financial institutes.
This type of risk is associated with the company’s inability to meet liability or equities such as accounts receivables, notes receivables, etc. For example, if the company has provided loans to several small businesses in the area and 10% of them are incapable of paying back that amount, the company will suffer losses. For such losses, the credit risk management makes necessary strategies before providing loans. The bad debt expense account is one such example.
Market risk is simply defined as the loss expectations a company keeps. These expectations are related to the price fluctuations and the firm’s investment. Here’s an example – a company invests $10,000 to make 100 products; thus, the company decides that the best price for each of its products is $1000. However, the company later on may realize that due to the fluctuations in the market, the product price should be kept $500 or else the company won’t be able to get customers. For such situations, the company creates a market risk management strategy beforehand to counter these problems.
Currency risk is also known as the foreign exchange risk. It is the loss expectation that can occur because of the adverse fluctuations in the currency rates. Companies which are directly involved in trading with currencies prepare a currency risk management strategy to counter these situations.
In this section we will discuss: