Guide to risk management - Revision history

imported>Doug Williamson: Update for LIBOR transition.

2022-04-25T21:07:20Z

Update for LIBOR transition.

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	* Changing market values of any debt outstanding.		* Changing market values of any debt outstanding.

	'''''Changing cost of interest expense or income:''''' This risk arises whenever a company refinances its borrowings, e.g. by issuance of commercial paper, drawdowns within a committed bank facility or making a bond issue. Therefore timing can be critical. Companies with debt charged at variable rates ~~(e.g. based on Libor)~~ will be exposed to increases in interest rates, while those companies whose borrowings costs are totally or partly fixed will be exposed to a fall in interest rates. The reverse is obviously true for companies with cash to invest.		'''''Changing cost of interest expense or income:''''' This risk arises whenever a company refinances its borrowings, e.g. by issuance of commercial paper, drawdowns within a committed bank facility or making a bond issue. Therefore timing can be critical. Companies with debt charged at variable rates will be exposed to increases in interest rates, while those companies whose borrowings costs are totally or partly fixed will be exposed to a fall in interest rates. The reverse is obviously true for companies with cash to invest.

imported>Doug Williamson: Categorise.

2018-02-22T12:37:17Z

Categorise.

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	[[Category:Book_Export]]		[[Category:Book_Export]]
			[[Category:Financial_risk_management]]

imported>Doug Williamson: /* 1 Risks of trading */ Correct alignment of currency rates

2016-03-23T15:12:24Z

1 Risks of trading: Correct alignment of currency rates

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imported>Jeeten.patel@thinkpublishing.co.uk at 15:04, 16 October 2015

2015-10-16T15:04:00Z

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	One interesting dimension of this risk is on future investments, rather than on just re-financings. Imagine an airline which needs to continually invest in new aircraft. These aircraft tend to be financed individually and so each new aircraft will come with an interest rate fixed in the market at some time, and therefore subject to risk.		One interesting dimension of this risk is on future investments, rather than on just re-financings. Imagine an airline which needs to continually invest in new aircraft. These aircraft tend to be financed individually and so each new aircraft will come with an interest rate fixed in the market at some time, and therefore subject to risk. So a new aircraft financed at a higher interest rate will need to earn more to repay itself. Seat prices would need to rise, all else being equal.


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	As a response to both these elements of interest rate risk, the choice of borrowing instrument used can be made to allow a firm to fix or float either element of its overall interest rate. A fixed rate bond issue fixes both the underlying interest rate and the spread for the life of the bond. A committed revolving bank facility fixes the margin for the life of the facility (subject to pricing grids) while allowing the underlying interest rate to fluctuate. Commercial paper issuance means both the underlying interest rate and the spread will fluctuate. Interest rate swaps are also used as a classic response to alter the fixed/floating mix of the underlying interest rate.		As a response to both these elements of interest rate risk, the choice of borrowing instrument used can be made to allow a firm to fix or float either element of its overall interest rate. A fixed rate bond issue fixes both the underlying interest rate and the spread for the life of the bond. A committed revolving bank facility fixes the margin for the life of the facility (subject to pricing grids) while allowing the underlying interest rate to fluctuate. Commercial paper issuance means both the underlying interest rate and the spread will fluctuate. Interest rate swaps are also used as a classic response to alter the fixed/floating mix of the underlying interest rate.

	'''''Changing business environment:''''' Changes in interest rates also affect businesses indirectly through their effect on the overall business environment. Generally, as interest rates and thus the cost of borrowing rise, usually as a response by the authorities to ~~high~~ economic activity, economic activity falls and profitability is depressed as firms face lower sales volumes in contracting markets. Some companies may find that they have a form of natural hedge against interest rate exposure. Common examples can be found in the regulated sectors such as the electricity industry or housing associations which are allowed to increase their charges by the Retail Prices Index (RPI). Interest rates tend to be higher when inflation is higher creating a natural offset. Nevertheless, this link can be a complex one, with some leading or lagging or even an inverted link, and it is notoriously difficult to model.		'''''Changing business environment:''''' Changes in interest rates also affect businesses indirectly through their effect on the overall business environment. Generally, as interest rates and thus the cost of borrowing rise, usually as a response by the authorities to higher economic activity, economic activity falls and profitability is depressed as firms face lower sales volumes in contracting markets. Some companies may find that they have a form of natural hedge against interest rate exposure. Common examples can be found in the regulated sectors such as the electricity industry or housing associations which are allowed to increase their charges by the Retail Prices Index (RPI). Interest rates tend to be higher when inflation is higher creating a natural offset. Nevertheless, this link can be a complex one, with some leading or lagging or even an inverted link, and it is notoriously difficult to model.

	'''''Changing market values of any debt outstanding:''''' Changes in interest rates will change the value of fixed rate debt and investments. Investors in these instruments are heavily affected but it can be a risk to issuers in some circumstances, and is a particular risk for firms with future healthcare or pensions commitments. As interest rates fall, the value of liabilities rises and vice versa. In this area of pension commitments quite complicated forces have been acting in the past few years. Underlying interest rates fell through the credit crisis (as measured by government bond rates), pushing up liabilities by that measure, although the accounting valuation of liabilities did not rise so strongly because of the rise in spreads on (mainly financial) AA bonds. This highlights how difficult it is to measure these liabilities.		'''''Changing market values of any debt outstanding:''''' Changes in interest rates will change the value of fixed rate debt and investments. Investors in these instruments are heavily affected but it can be a risk to issuers (i.e. reflecting most corporate activity in these markets) in some circumstances, and is a particular risk for firms with future healthcare or pensions commitments. As interest rates fall, the value of liabilities rises and vice versa. In this area of pension commitments quite complicated forces have been acting in the past few years. Underlying interest rates fell through the credit crisis (as measured by government bond rates), pushing up liabilities by that measure, although the accounting valuation of liabilities did not rise so strongly because of the rise in spreads on (mainly financial) AA bonds. This highlights how difficult it is to measure these liabilities.


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	This is best approached on a “bottom up” ERM basis, and the treasurer should get out and about to operating divisions/units to find out what they perceive to be the risks to their objectives, although the treasurer should have a good understanding of what to expect. There will also be some risks, e.g. translation risk, which are “centralised” and can be viewed as “ownership” risks. Liquidity should be viewed from all directions.		This is best approached on a “bottom up” ERM basis, and the treasurer should get out and about to operating divisions/units to find out what they perceive to be the risks to their objectives, although the treasurer should have a good understanding of what to expect. There will also be some risks, e.g. translation risk, which are “centralised” and can be viewed as “ownership” risks. Liquidity should be viewed from all directions.

			This research is often the most difficult part of any risk strategy. Treasurers may not have the time to make full investigations of their business and reliance on reporting from them can be unreliable. For example, a full analysis needs to look at pricing policy, orders, any risks dealt with contractually, purchasing policy, competition and so on.

	One common approach is to analyse the income statement and balance sheet on a line by line basis and identify those financial risks which apply to each line. This analysis might be conducted with the set of questions illustrated for each main subject.		One common approach is to analyse the income statement and balance sheet on a line by line basis and identify those financial risks which apply to each line. This analysis might be conducted with the set of questions illustrated for each main subject. This approach might usefully be extended to the cash flow statement to check for any obvious liquidity or other issues such as changes in working capital, and investment or disposal programmes. Other approaches (more suitable for discussions with non-financial personnel) may be to identify key business drivers or business processes and analyse the financial risks inherent in those drivers or activities.


	This approach might usefully be extended to the cash flow statement to check for any obvious liquidity or other issues such as changes in working capital, and investment or disposal programmes. Other approaches (more suitable for discussions with non-financial personnel) may be to identify key business drivers or business processes and analyse the financial risks inherent in those drivers or activities.


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	With a measure, even if qualitative, we can design a Key Performance Indicator (KPI) for that risk and then target a particular level and see what effect certain actions have on that KPI and use it as a basis for reporting. Examples of measures that might be used in risk management could include:		With a measure, even if qualitative, we can design a Key Performance Indicator (KPI) for that risk and then target a particular level and see what effect certain actions have on that KPI and use it as a basis for reporting. Examples of measures that might be used in risk management could include:
	* Probability of interest cover falling below threshold as a measure of interest rate risk.		* Probability of interest cover falling below threshold as a measure of interest rate risk.
			* Headroom over the next two years
			* Facilities maturing in the next two years
	* Value at risk from transaction exposures.		* Value at risk from transaction exposures.
	* Number of non-bank lender meetings held every year and participation at meetings.		* Number of non-bank lender meetings held every year and participation at meetings.
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	This policy relates directly to a risk, and tells us all we need to know about how to manage it, from measurement to who has authority to make decisions to what the target is for the measurement, i.e. the KPI. It concludes with how the KPI is to be reported and what can be done to improve the process or modify it as circumstances change. Examples of targets for KPIs leading on from the measures shown above could be:		This policy relates directly to a risk, and tells us all we need to know about how to manage it, from measurement to who has authority to make decisions to what the target is for the measurement, i.e. the KPI. It concludes with how the KPI is to be reported and what can be done to improve the process or modify it as circumstances change. Examples of targets for KPIs leading on from the measures shown above could be:
	* Interest cover to be greater than 3.0 on a 95% confidence basis over an 18 month period.		* Interest cover to be greater than 3.0 on a 95% confidence basis over an 18 month period.
			* Forecast headroom over the next two years to always exceed $5 million
			* Facilities maturing in the next two years to be less than 15% of all facilities
	* Value at risk from transaction exposures to be less than £100,000 on 95% confidence basis over the life of the exposures.		* Value at risk from transaction exposures to be less than £100,000 on 95% confidence basis over the life of the exposures.
	* Non-bank lender meetings to be held every six months with target of 30% participation of lenders in the register.		* Non-bank lender meetings to be held every six months with target of 30% participation of lenders in the register.

imported>Jeeten.patel@thinkpublishing.co.uk at 14:56, 16 October 2015

2015-10-16T14:56:10Z

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	A Singapore-based consultant owns a US-based subsidiary, the business of which is completely domestic and has no exposure to any currency other than the US dollar. The Singapore parent must translate the US dollar revenues and balance sheet when it reports in Singapore dollars. This is of no consequence to the US subsidiary and so is a risk of ownership.		A Singapore-based consultant owns a US-based subsidiary, the business of which is completely domestic and has no exposure to any currency other than the US dollar. The Singapore parent must translate the US dollar revenues and balance sheet when it reports in Singapore dollars. There is no need to physically sell any of the US dollars. This is of no consequence to the US subsidiary, which think only in US dollars, and so is a risk of ownership.


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	Transaction risk requires a treasurer to get out and see what’s going on in his firm, a classic case of ERM in action. He or she will not know by sitting at their desk, and even getting reports from operational management may not be as reliable as he/she thinks.		Transaction risk requires a treasurer to get out and see what’s going on in his firm, a classic case of ERM in action. He or she will not know by sitting at their desk, and even getting reports from operational management may not be as reliable as he/she thinks.
	* '''''Pre-transaction risk:''''' These are contingent risks and arise where the firm has made an offer to enter into a commitment that would become a transaction risk if the offer is accepted. Examples include publishing a price list in the firm’s own currency which has foreign currency or commodity costs inherent in it, publishing price lists in a foreign currency under similar circumstances and any case of bidding for a contract with costs which are not certain.		* '''''Pre-transaction risk:''''' These are contingent risks and arise where the firm has made an offer to enter into a commitment that would become a transaction risk if the offer is accepted. Examples include publishing a price list in the firm’s own currency which has foreign currency or commodity costs inherent in it, publishing price lists in a foreign currency under similar circumstances and any case of bidding for a contract with costs which are not certain. Risk increases with the length of time that the price list is valid or the price is left open.
	* '''''Economic risk:''''' This is perhaps best described as the risk arising on future transaction streams. It is essentially about the competitive position of the firm. Market rates may move so that the pricing model of the firm becomes less competitive. The risk reflects the fact that no hedge ~~can be~~ forever and the firm’s marginal exposure to market rates cannot be avoided.		* '''''Economic risk:''''' This is perhaps best described as the risk arising on future transaction streams. It is essentially about the competitive position of the firm. Market rates may move so that the pricing model of the firm becomes less competitive. The risk reflects the fact that no hedge lasts forever and the firm’s marginal exposure to market rates cannot be avoided.


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	This is an example of ERM in practice as the response to changing exchange rates in both firms is likely to be as much about managing the commercial relationship with ~~the customer~~ over a long period, as about immediate action in the financial markets.		This is an example of ERM in practice as the response to changing exchange rates in both firms is likely to be as much about managing the commercial relationship with customers over a long period, as about immediate action in the financial markets.

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imported>Jeeten.patel@thinkpublishing.co.uk at 13:32, 16 October 2015

2015-10-16T13:32:02Z

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imported>Doug Williamson: Protected "Guide to risk management" (‎[edit=sysop] (indefinite) ‎[move=sysop] (indefinite))

2015-07-27T12:55:02Z

Protected "Guide to risk management" (‎[edit=sysop] (indefinite) ‎[move=sysop] (indefinite))

← Older revision

Revision as of 12:55, 27 July 2015

imported>Jeeten.patel@thinkpublishing.co.uk at 17:02, 9 December 2014

2014-12-09T17:02:31Z

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imported>Jeeten.patel@thinkpublishing.co.uk at 16:16, 1 November 2014

2014-11-01T16:16:44Z

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	\|header2 =		\|header2 =
	\| label2 = David Blackwood		\| label2 = David Blackwood
	\| data2 = [http://www.synthomer.com ~~Chief Financial Officer,~~ Synthomer plc]		\| data2 = Chief Financial Officer, [http://www.synthomer.com Synthomer plc]

	\|belowstyle = background:#ddf;		\|belowstyle = background:#ddf;

imported>Jeeten.patel@thinkpublishing.co.uk at 16:15, 1 November 2014

2014-11-01T16:15:47Z

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	\|header1 = ~~Authors~~		\|header1 = Author
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