Financial risk management solutions

- Companies are up against financial market risks driven by global factors like central banks, OPEC and the weather. Understandably, companies want to insulate themselves from these risks, and they use global financial market instruments to do it. Being aware of these risks and potential risk management solutions could save your company from a lot of financial pain, pain that could put a company out of business. This happened to a number of smaller oil producers when the price of crude oil fell sharply in 2015 and 2016. Companies that didn't hedge their downside oil price risks at a high enough oil price to keep their businesses afloat went bankrupt or were pushed to the edge of bankruptcy. In this video, we'll look at solutions that corporations use to manage their financial market risks and avoid the pain train that big swings in commodity prices, currency rates and interest rates can bring. Corporations manage risks that they don't want to own by hedging them. Hedging is a specific way companies reduce financial market risks by using contracts, sometimes called financial market instruments. These instruments are contractual obligations that involve a payout and are dependent on movements in financial markets. Think of them as a kind of insurance against financial market moves. These contracts are often provided by banks, trading merchants and other financial market players. A company that buys aluminum could lose money if the price of aluminum rises. So it hedges that risk using financial market contracts so that it can lock in the price of aluminum at a level it likes. Of course, a company could just buy all the aluminum it will ever need in advance. That would reduce the price risk, too, but that strategy could use up all of a company's working capital. And a company wants its money working, not sitting in inventory in a warehouse. After all, tying up all of its money could eventually force a company out of business, so another solution is needed. And that's where hedging comes in. It's a way to reduce your risks at a relatively low cost. All financial market instruments, including options, swaps, futures and forwards provide different ways to manage risk, but they all have one thing in common, two parties. One party is effectively owning the risk, and another is selling it. As such, all solutions unfortunately introduce counterparty risk, which is the risk that a party you have an agreement with could go out of business or otherwise default on its obligations. Since a contract has two sides, you need to believe that the other side is a stable partner. The risk that they are not is counterparty risk. Of course, there are more extreme solutions to manage financial market risks, like making an acquisition, i.e. buying or divesting, i.e. selling a business, exiting a market completely or hoarding the commodity or currency you'll need for many years to come. These are all usually much more complicated and expensive strategies than using financial market instruments. So how would you like to address your currency, commodity and interest rate risks?