Use of Derivatives in Risk Management Research Paper

Use of Derivatives in Risk Management - Research Paper Example The global economic environment and the financial market have evolved drastically over the past decade. With the advent of information technology at a rapid pace, the financial markets of the world are now closely integrated. Due to this phenomenon of the world being a global village, a turbulence originated in a far distant financial market can have eventual consequences all across the globe. With the revolution in the communication technology, the access to information is instantaneous and thus the subsequent market reactions. It is of prime importance to understand the concept that how does financial risk arises in order to safeguard’s one asset from deteriorating while being exposed to such risks. For any organization or a company, the financial risk arises by entering into a financial transaction such as sales, purchase, investing into securities and bonds, sanctioning of loan and advances, mergers and acquisition transactions, debt financing etc. Financial risk is directly co-related to the prevailing financial prices in the markets, as the fluctuation in these prices causes an increase in the cost to the companies, reduction in the revenues and thus adverse impact on the profitability of the company. These underlying financial prices can be anything ranging from the market interest rates, exchange rates and commodity prices. Other aspects which yield financial risk in the transactions are dealing in derivatives and internal failures of the process and people of any organization. The financial r isk management process mainly copes with the uncertainties resulting from the financial market. The first and foremost step in this process is to identify the current exposure of the company and devise strategies accordingly keeping into consideration the priorities of the company. It depends upon the proactive decision making and the decisiveness of the company on how to cope with the current exposure of the company. In general, companies do realize that avoiding all risk is not possible in order to operate and thus they end up accepting a considerable amount of risk. Risk management is considered to be an ongoing process as the strategies needs to be updated and refined keeping into consideration the market norms and requirements. These changes are primarily brought about by the changes in the expectation about the market rates, business norms and practices and the international financial scenario. The most common strategy practiced by the companies all across the global financial market is to curtail their exposure to risk through the use of derivatives. Risk Management Process Risk management process is a continuous and iterative process which requires analysis of both internal and external risk factors. The