Managing Increased Financial Risk

Managing Increased Financial Risk

We have seen a period in which the oil price rose to $147 a barrel and then fell back dramatically. The wider commodities market followed suit. Inflation rose to its highest level for many years before easing back. Property prices have been savaged, following a protracted boom. Only interest rates have remained relatively benign compared to the extremes of the past.

Volatility has been traded as a market index for many years, but in 2008 alone it hit several spikes. It has become a fact of life. Markets are now driven mainly by fear—fear of being caught out when prices fall or fear of not being in the market as prices rise. Add to that the power of short sellers and you have a scary scenario for borrowers and investors, whether individuals or corporate.

Protecting or insulating yourself or your company against financial risks is known as “hedging.” The principle of hedging is easily understood—it’s like an insurance premium. In practice, the instruments generally used are known as “derivatives.” These are poorly understood and, given the recent financial mess, probably viewed with fear or trepidation.

This article attempts two things: first, to put forward a more objective approach for companies wishing to improve their financial efficiency at a managed level of risk; and second, to demystify financial risk, making it a more approachable topic for the average manager or director.

Posted in: Managing Increased Financial Risk