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Financial risk management

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FINANCIAL RISK MANAGEMENT Introduction In the previous lesson we learnt how to choose an investment portfolio that minimizes risk. In this lesson we will learn how to use financial instruments in managing financial risks. Objectives By the end of this lesson, you should be able to: ▪ Enumerate the instruments used to manage financial risk. ▪ Explain how forwards, futures and options can be used to manage financial risk Financial derivative instruments used in managing risk include; Forward contracts Futures contracts Options These are applied in different ways to manage risk a) Hedging This is to invest on both sides to avoid loss. Most producers and trading companies enter the derivatives markets to shift or reduce the price risks in the underlying asset markets to secure anticipated profits. Example A Page | 1 A US company will pay 1 million British Pounds to a British supplier in 90 days. Now it faces a currency risk due to the uncertain USD/Pound exchange rates. If the Pound goes up, it will cost the company more for the payment, thus will hurt the company's profits. Suppose the exchange rate is currently 1.6 USD/Pound, and the Pound may go up, the company may consi ...
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