Financial markets are platforms where customers and agents trade with stock or bonds. The financial markets encounter risks which affect the trading activities. Every business is prone to risks due to the changes in the environment and the development of technology. Risks affect the internal and external business environment. Business risk is the probability that an organization will not meet the profit goals or incur losses. The market might not develop as presumed by the analysts due to the increase in the risks. Risks can lead to bankruptcy or an increase in the company’s losses. The risks in a firm are influenced by sales, product prices, liquidity problems, competitive changes, actual expenses, economic fluctuations, and international policies. Some risks can increase the profits, but intense challenges can lead to the closure of the business. Further, a company might not provide the shareholders with the presumed returns due to the high number of risks. Corporations with high risks should select a capital system that has a low deficit rate to ensure it meets its daily financial needs. The kinds of business risks include strategic, compliance, operation, and reputation. It is essential to assess the business risks to identify their intensity on the organization and develop mitigation strategies.
Business Risks
Operational Risk
Operational risks involve the change in value due to the differences in the expected profits and incurred losses. Employees or organizational members are responsible for the occurrence of operational risks. The main kinds of operational risks include fraud, legal challenges, safety, and privacy protection. Operational risks influence the daily operations of a company. The operational risks occur when the employees fail to perform the daily activities (Malz, 2011). An illustration of operational risk is using an obsolete information system and a weak organizational structure. Further, interruptions in the production process are illustrations of operational risks. Another example of operational risk is a false presentation of financial statements to the company’s shareholders.
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Compliance Risks
Compliance risks involve the application of rules to regulate the operations in an organization. Companies experience challenges in adhering to the government policies. An illustration of compliance risk is an organization operating in an industry that incorporates strict laws. The beverage sector applies distribution or specific laws in the production process. Companies must ensure they comply with the policies as directed by the government. The government regulations focus on trading activities, medical care, logistics, recruitment, and payment of taxes (Malz, 2011). Business should have a legal section that focuses on the reduction and elimination of compliance risks. Also, a corporation should hire risk management professionals to assess the cause of the problems and develop mitigation plans. The other business sections should collaborate to reduce the compliance risks that affect the operations negatively (Malz, 2011). Managers need to encourage employees to follow the policies.
Reputational Risks
Reputational risks affect the image and product brand of a corporation in the industry. Many clients purchase products from companies that have a good reputation and offer high-quality products. Reputation enhances the reliability of a company and attracts customers (Hampton, 2011). Companies lose customers when the brand reputation is influenced negatively. For instance, the reputation of a firm can be affected by legal concerns, recalls, customer dissatisfaction. Businesses should solve reputational risks immediately to maintain customer trust. The risk management employees should have plans on mitigating the reputational risks once they emerge. The strategies should include acting ethically and morally to build the company’s image (Hampton, 2011). Employees should not misuse the firms or investors finances. Besides, the staff should produce high-quality goods and provide excellent customer care.
Strategic Risks
Strategic risks involve the failure to meet the set goals in the organization. In this case, the operations of the firm are not aligned with the goals. Strategic risks can influence the growth and sustainability of a firm in the market (Hampton, 2011). An organizational plan is not effective in reducing risks because it requires time to incorporate in the operations. The changes in the market and competition cannot be eliminated by implementing strategies. The strategic risks affect the company’s activities because the plans have no immediate effect on the economic fluctuations (Hampton, 2011). A firm must review the goals and plan to reduce the strategic risks. Also, the corporation must assess the industry competition to realign the objectives.
Technological Risks
Technology risk involves the disruption of organizational activities due to the use of outdated equipment. The risk affects the overall performance of the business because the equipment is non-functional. The business can experience delays in completing tasks or projects (Hampton, 2011). Technology risks can also influence the security and reputation of the corporation. Most firms depend on technology for efficiency, research data, analysis, communication, innovation, and promotion (Hampton, 2011). A company needs technology to meet the operational goals. Therefore, corporations need to adopt advanced technology to enhance safety, privacy and meet the goals. Modern technology can increase productivity which reduces operational risks.
Political Risks
Political risks are the challenges that a company experiences due to changes in government policies. The organizational has to follow the laws provided by the government. In case of any amendments, the organization has to transform the operation to meet government recommendations (Hampton, 2011). Some illustrations of political risks include measures, tax levels, policies for global trade, and government actions. Some companies do not adhere to the policies or ignore, but they do not meet the long-term goals. It is essential to assess the political risks to identify the gaps and develop plans. Companies can penetrate and grow in new markets through effective assessment of political challenges (Hampton, 2011). Therefore, businesses gain a competitive advantage in the market.
Safety and Health Risks
Safety and health risks involve the accidents or injuries that the employees are likely to encounter in the work environment. The risks also focus on the effects of the work environment on the employees’ health. Companies are responsible for enhancing employees’ safety in the work setting (Horcher, 2013). The occurrence of safety and health risks depends on the business atmosphere. The risks can occur in case the managers do not advise the employees on the potential effects of the surrounding on their health and safety. Further, the employees can face safety and health risks in case the managers do not regulate the dangerous work systems in the environment. Firms with an unsafe environment have legal liabilities and low employee retention. The businesses with an unsecured work atmosphere have a high probability of being closed down (Horcher, 2013). Organizations should enhance the surrounding at work to reduce the employees’ health risks.
Employee Attendance Risks
Employee attendance risks involve low work turnout. It is a common challenge in the companies, and there are no particular strategies to mitigate absenteeism. Employees fail to attend work due to short-term diseases, household emergencies, or long-term diseases (Hampton, 2011). Organizations should regulate truancy by incorporating laws. Employers should not dismiss employees due to non-attendance to work. Employee dismissal can cause liability to a corporation. The managers can reduce absenteeism by establishing a positive atmosphere at work. The executives should appreciate the staff after they complete the tasks correctly (Hampton, 2011). The corporation should increase employee morale by presenting rewards and giving allowances.
Financial Risks
Financial risks involve the probability that the investors might lose money after investing in a corporation that cannot meet its financial obligations. The investors can make losses in case a firm uses the debt financing approach. The company will settle the creditors’ accruals before compensating the investors in case of insolvency. Further, financial risk focuses on the probability that a company or state defaults its financial assets (Hampton, 2011). As a result, the stakeholders make losses. The types of financial risks affect the margins of a company.
Interest Rate Risk
Financial risks occur due to an increase in the interest rates in the market. An increase in the interest rates influences the investment negatively. The investors make losses because the return rates reduce. However, investors make profits in businesses that understand the changes in the interest levels (Jacque & Jacque, 2013). Thus, the corporations balance their portfolio to reduce risks and generate profits.
Foreign Exchange Risks
Foreign exchange risk involves the devaluation of currency due to the economic fluctuations in the financial sector. The devalued currency is sold at a loss. Investors and firms that deal with exports or imports are prone to foreign exchange risks. The businesspersons and company can make profits after they hedge their currencies (Jacque & Jacque, 2013). They can also use forwards or futures contract methods to mitigate the effects of the foreign exchange rates on the margins.
Commodity Risk
A commodity is an ordinary product that can be sold. Examples of commodities include gas, electricity, grain, or gold. Commodity risks focus on the predicted fluctuations of the product prices (Jacque & Jacque, 2013). The prices of the products are based on the predicted rates. In case the costs reduce, the traders can incur losses. Traders quote favorable prices to cater for losses if the commodity prices decrease in the future.
Credit Risk
Credit risks occur if the debtor does not fulfill the agreement. A debtor can default loan payments or compensate the creditor with tangible assets. Loans are risky forms of credit in the finance sector. A creditor incurs losses if the debtor declines to repay the loan or compensates using a tangible item (Jacque & Jacque, 2013). However, assets reduce value after some time. The other credit risks include credit cards, foreign exchange, and mortgages.
Liquidity Risk
Liquidity risks focus on the low market of investments which cannot be traded quickly. Small financial assets have the most considerable liquidity risk. The liquidity risk of financial assets around the world decreased during the 2008 global economic crisis. Consequently, most investors sold their financial assets to avoid losses. Liquidity risk can also occur when an investor or organization cannot fulfill the short-term financial measures (Allen, 2013). For instance, an organization might not convert the assets to cash due to the lack of customers in the market. Financial managers should manage cash flows appropriately to meet the short and long-term obligations.
Systemic Risk
Systemic risk is the disintegration of the whole industrial system. The failure of one market spreads to the entire industries in the world. It was the leading cause of the 2008 global financial crisis. An illustration f system risk is a bank run which easily spreads to markets in the globe (Allen, 2013). Systemic risk can be reduced by imposing regulations on one industry which spreads to other industries.
Measuring Risks
Companies need to measure to increase efficiency. The measurement of financial and business risks should be among the organization’s goals. Some corporations measure risks when there are changes in the market and actual profits. Profits and risks vary on the basis of industry. Thus, industries measure risks using different methods. Industries consider the consumer demand on goods or services when assessing the risks (Horcher, 2013). A decrease in economic growth increase the unemployment rates but reduces the consumer spending rates. The profits in the business reduce due to a decrease in the demands for products and facilities (Horcher, 2013). The business risks increase after the reduction of the firm’s profits.
Corporations need to manage finances to increase profits and expand to other industries. The management of finances in a company is essential for financial sustainability. A company needs to assess the business and portfolio plans to develop effective financial strategies. Investors use financial ratios to examine the strength and risks of an organization (Horcher, 2013). The businesspersons and organizations make investment decisions after getting the results of the financial assessment. The common financial ratios used by entrepreneurs and firms include debt to capital, leverage, current, quick, and debt to capital (Horcher, 2013). Companies can examine the ratio of cash flows to debt to determine the financial risks. The organization can compare the assets and interest coverage to identify any financial challenge (Horcher, 2013). A high debt to equity ratio indicates that there any many financial risks in the business.
Organizations can install software programs to assess the business and financial risks. The software programs assist in identifying the specific risks that influence the financial performance in the company (Horcher, 2013). The software can detect the systemic risks including the upstream or downstream factors. The programs can assess the areas that can improve by developing centralized measures in the organization (Horcher, 2013). The company can eliminate separate activities to increase productivity.
Companies can assess the percentage of risks in critical areas. The involvement of managers in the risk assessment process is essential in providing accuracy. A high percentage of the risks in the vital process indicate that the organization needs to take immediate action (Horcher, 2013). A firm can also measure the percentage of the primary risk mitigated or monitored sections. Corporations should use a collection of standards to establish uniformity in the persistence of risks (Horcher, 2013). A company is keen on changes that occur in the risk monitoring sections. Subsequently, a corporation can prioritize the activities that should be controlled after determining the weak areas.
Global Initiatives
Global initiatives are significant aspects of corporations when considering the management of financial risks. The global efforts assist the organizations to decrease the probability of financial losses (Horcher, 2013). Examples of global efforts include the identification of risks and weak areas in the firm. The business develops plans to improve the weaknesses to increase efficiency.
Settlement Initiatives
The initiative aims to reduce the risks of separate payments of foreign exchange transactions. Financial organizations encounter settlement risks because they buy or sell derivatives. The companies have international clients, and this increases the foreign exchange risks. The payments on financial assets are made electronically. Settlement risk occurs when external parties decline to complete the payments (Horcher, 2013). Foreign traders and corporation can use the CLS (Continuous Linked Settlement) to facilitate concurrent payments. The CLS system reduces the settlement risks. CLS system facilitates transactions for different currencies where international financial institutions can conduct trade (Horcher, 2013). Central banks use the CLS system to make real-time settlements with foreign countries. CLS banks provide accounts for foreign currency (Horcher, 2013). Settlement initiatives decrease the financial uncertainties in the industry.
Trading Initiatives
Each party in a derivatives contract must uphold integrity and honor the obligations of the terms. The pioneers for trading derivatives depend on particular risk management techniques to mitigate challenges. Exchanges use different approaches to handle risks including clearing stores to settle foreign exchange payments. The clearinghouse facilitates transactions of every business activity including defaulted payments to ensure traders meet the contract terms (Horcher, 2013). The exchanges consider the present market rates and the maximum prices changes when making transactions. Financial institutions use specific methods to decrease the trading and settlement risks due to an increase in the demand for derivatives (Horcher, 2013). The CLS system is used to reduce counterparty challenges.
Payment Initiatives
Many payments are conducted internationally using global transaction systems. The IPS is effective in reducing transaction risks. The traditional payment systems were not efficiency in issuing funds. The TPS had many chances that hindered the flow of payments from the client to the trader. The modern payment systems have minimum risks as compared to the traditional structures. For instance, the default of a transaction cannot influence the other financial activities in the system (Horcher, 2013). The current stakeholders of the modern IPS include central banks, financial organizations, payments partners, and directors. The shareholders collaborate in transforming the international payment structure which is reliable (Horcher, 2013). Many corporations have installed real-time systems to facilitate swift transactions. Systemic risks are reduced by incorporating intentional shifts (Horcher, 2013). Payment initiatives are useful in reducing financial risks.
Capital Adequacy Initiatives
The Basel committee created a contract with central banks of developed countries. The purpose of the agreement was to develop a standard minimum capital for the corporation in the states. One of the primary achievements of FRM is the development of capital adequacy standards. The capital standard is the minimum amount of money that a financial organization must sustain when conducting banking business (Horcher, 2013). The primary rule of capital adequacy is that risky tasks must have more capital. The amendment of the Basel Law provided a chance for revising the conditions (Horcher, 2013). The revised law, Basel 11, was established in 2004. The law contains hazardous capital conditions. Basel 11 law allows banks to utilize the internal structures to compute capital after examining the risks (Horcher, 2013). The accord does not give actual information on the risk management laws or strategies. The new accord establishes choices for banks and managers to compute the capital standards for credit or operational uncertainties. The aim of designing Basel 11 was to enhance global banking sustainability by developing capital adequacy provisions (Horcher, 2013). Basel 11 has integrated the capital provisions with the risk control strategies which consist of three primary sections. The pillars are:
Least capital provisions
Management assessment and procedures
Market regulation
Accounting and Regulatory Initiatives
Financial analysts use the IAS to calculate the fair and market rates for derivates. Managers reduce theft on reporting by establishing regulatory laws. Corporations use the Sarbanes-Oxley law to ensure that employees adhere to the restrictive policies. Many organizations have met the expenses of changing the accounting methods for derivatives (Horcher, 2013). The changes have increased openness between businesspersons and creditors.
In conclusion, organizations encounter multiple financial and business risks. The risks can be controlled by incorporating technology and new processes into financial activities. Financial institutions should be aware of changes in industry trends and technology to control the risks. It is essential to create a baseline to identify the intensity of the risks in the market. Companies should diversify the portfolio to reduce the risks.
References
Allen, S. (2013). Financial risk management: A practitioner's guide to managing market and credit risk . Hoboken, N.J: Wiley.
Hampton, J. J. (2011). The AMA handbook of financial risk management . New York: American Management Association. Bottom of FormBottom of Form
Horcher, K. A. (2013). Essentials of financial risk management . Hoboken, N.J: Wiley.
Jacque, L. L., & Jacque, L. L. (2013). Management and control of foreign exchange risk . Boston: Kluwer Academic Publishers. Bottom of Form
Malz, A. M. (2011). Financial risk management: Models, history, and institutions . Hoboken, N.J: John Wiley & Sons.
Rush, J. (2012). Foreign Exchange Risk Management . John Wiley & Sons Inc.
