November 25, 2012

MA0042 [Treasury Management] Set2 Q1

Q.1 Explain any two major risks associated with banking organization.

Ans:

Treasury exposure allows treasury management to various risks in the organisation. Following are the few treasury exposures in an organisation:

Financial exposure: The treasury management in the organisation are disclosed to the powerful analytics that enable to measure the global treasury operations and control financial market risks. It analyses the price and risk profile of financial dealings on a pre-dealing basis. The exposure in foreign exchange market is intense; hence hedging towards these risks by integrating business exposures and treasury transactions helps an organisation to manage financial risk and stay profitable.

Foreign exchange exposure: This occurs due to the low profits and adverse fluctuations in foreign exchange rates. Many organisations suffer from foreign exchange risk by making purchases or sales in foreign currency or by owning assets or liabilities in foreign countries. Hence a relevant course of action must be implemented to reduce exposures in business operations.

Currency exposure: It deals with future cash flows arising from domestic and foreign currencies that involve assets and liabilities and generating revenues which are susceptible to variations in foreign currency exchange rates. Hence the identification of existing potential currency relationship that arises from business activities includes hedging and other risk management activities.

Event exposure: This happens due to a sudden change in the financial market during an investment (an event) that has a detrimental effect on the value of that investment. It is often associated with corporate bonds.

Commodity exposure: This happens due to variations in the prices of commodities which change the future and magnitude of market values. The commodities depend on any production including foreign currencies, financial instruments or any physical substances. Hence treasury management is liable to deal with various risks like price, quantity, cost that are associated with commodities.

Need for risk management
Risk management helps in minimising the failure of business activities which are based on finance or performance in the organisation. It is the responsibility of the organisation to manage risk effectively and overcome hindrances affecting the overall growth of the organisation.

Hence risk management is required in the organisation for the following purposes:
To identify the risk in business activities and establish a plan to manage risk and minimise the negative effects.
To improve the efficiency of strategic and business plans, and effective use of resources among the stakeholders in the organisation.
It helps in increasing the ability to deliver products to the customers within the stipulated time and reduce the production cost.
It helps to control the negative political, economic, and financial factors which may harm an organisations growth.
To overcome sensitive internal environment, social or safety issues or regulatory and licensing conditions available in most of the organisations.
To focus on internal audit process and robust contingency planning.

Corporate risks
Corporate risks include non-financial organisational risks that arise during challenging times in the economy. . The corporate risk varies for different organisations based on factors like size, diversity in business activities and sources of capital etc. According to the assumptions of Modiglani and Miller (1958), Corporate risk is a redundant activity. It is mainly concerned with progressive tax rate and expecting costs from financial distress. The value of an organisation depends on the changes in exchange and interest rates, and commodity prices. Hence the corporate risk manager quantifies the exposures occurring in the organisation to reduce risks that hamper the financial sector.

Corporate risk is further divided into market, credit and operational risks. Credit risk experiences less challenges compared to operational and market risks. The operational risk occur due to certain factors like back office errors, fraud, natural disaster etc. The organisation faces market risk with respect to commodity price risk and foreign exchange risk.

Hidden risks
Hidden risks are related to cash and financial risk in an organisation. These risks might harm the growth of an organisation. Hence the manager is responsible to identify the risk and implement relevant actions to eliminate it. A complete and accurate exposure calculation can eliminate the hidden risks. Hidden risks are also concerned with financial accounting. Financial risk is the probability when an actual return on an investment is lower than the expected return. They are the uncertainties in business leading to variations in expected profits and losses. Uncertainties related to several risks affect the net cash flow of any business organisation. Lower uncertainties have lower variations in net cash flow, and vice versa.

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