Chapter 8 Flashcards
Definition of financial risk
A risk of a change in a financial condition such as an exchange rate, interest rate, credit rating of a customer
Definition of political risk
Risk arising from actions taken by a government that affect financial aspects of the business
Mangement of policitical risk
Researching country’s current and historic political and economic stability
Entering into foreign JV/part owenrship by foreign country investors
Using local financing
Making use of local suppliers and workforce
Definition of interest rate risk
Risk of gains or losses on assets and liabilities due to changes in interest rates
Definition of refinacing risk
Risk that loans will not be renewed when needed, or only renewed at a higher interest rate
Definition of currency risk
Risk that arises from possible future movements in exchange rate
What is hedging?
A way of using financial instruments to reduce the risk of adverse price movements
Help companies to ‘fix’ the price of something they plan to buy or sell in the future
What are the benefits of hedging?
Can provide certainty of cash flows
Risk will be reduced
Reduction in probability of financial collapse
May be perceived to be a more attractive employer to risk-averse managers
May reduce taxes
Arguments against hedging
May harm investments of shareholders with diversified portfolio
Significant transaction costs
Lack of expertise within the business
Complexity of accounting and tax issues
Gains and losses may cancel out in the long run
Defintion of a derivative
Financial instrument whose value depends on the price of some other financial asset or underlying factor
What does VaR assess?
the scale of the likely loss in value of a portfolio in a specified time period at a defined level of probabilty
Currency risk
Risk that arises from possible future movements in an exchange rate
Economic risk
Change in the economy, home or abroad, which can affect the value of transaction before a commitment is made
Translation risk
Risk related to buying or selling on credit in foreign currencies
