Financial risk management involves managing the market risk and credit risks of the business in order to create the economic value of the firm. The financial risk management mainly stresses on when and how the firms should hedge with the help of the financial instruments.
This is done in order to handle the expensive exposures to the risk elements. Just like the management of general risk, the financial risk management also includes identifying the source of the risk, measuring the weight of risk and then applying measures to address those risks.
The various types of risks that a business can experience are – foreign exchange risk, volatility, shape, inflation, liquidity, sector and many other types of risks. Basel Accord is the concept that is used by the entire international banking sector of the world in order to deal with the financial risks.
It includes the banks to track the risks and also expose the risks like credit, operational and market risks. According to the theory of finance, when a firm increases the value of shareholder, it should take up projects.
The concept of finance theory also tells that the managers of the firm cannot produce value for the investors or shareholders of the firm by starting those projects that the firm investors could do otherwise at the same cost for themselves. Now it can be implied that according to the financial risk management theory, the risks that firm shareholders can hedge for themselves at the same cost should not be dodged by the firm managers.
From the concept of hedging irrelevance proposition we can draw the conclusion that the firm managers can use the tool of financial risk management in order to create value for the shareholders. This involves the firm managers to determine which are the risks that the firm can manage more cheaply than the shareholders. Generally the market risks are the most suitable candidates for the firms for the financial risk management.
Last Updated on : 27th June 2013