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Financial Risk Management Research Paper


Introduction

A risk refers to the probability that a certain action would cause an undesirable outcome. The undesirable outcome is commonly regarded as a loss. A number of scholars have defined risk as a potential loss.

Although it is believed that every action is associated with risk, it has been confirmed that certain activities are risky than others. On the other hand, a financial risk refers to an unanticipated variability of returns. A financial risk commonly occurs due to changes in various factors associated with the market. It may also result from the firm’s operational activities, such as fraud (Covello & Allen 1988, p. 69).

Several mechanisms are used in controlling and managing the level of risks. Such mechanisms include hedging. Hedging refers to approaches that are used in alleviating risks that lead to losses in a firm. During the process of mitigating a risk, financiers normally combine assets in various proportions to ensure that their movements offset each other (Hubbard 2009, p. 47).

Types of financial risks faced by various firms

Various companies are exposed to a variety of financial risks. However, every organization endeavours to manage these risks in different ways. Before proceeding to the analysis of financial risks that affect Wal-Mart, De La Rue, Marks and Spencer Group Plc (M&S), Tesco Plc and BT Group Plc, it would be essential to determine various types of financial risks (Dorfman 2007, p. 40).

Credit risks

Most firms face credit risk when the account receivables are not paid on time. This denotes that customers fail to pay debts as agreed in the initial agreement. The credit risk is mainly associated with firm’s receivables, investment securities and clients.

The exposure of a firm to the credit risk mainly arises from non-payment of extended credit as per the time agreed on the contract. Firms usually limit cash transactions, derivative counterparties of superior quality credit, and the credit amount extended by financial institutions (Moteff 2005, p. 12).

Liquidity risks

This type of risk establishes whether a firm is able to meet its short-term obligations. The firm manages liquidity risks to ensure that it has adequate cash to meet its short-term obligations when time is due.

An efficient liquidity management of a risk implies the maintenance of adequate marketable security and cash, the accessibility of finances through sufficient credit facilities, as well as the capability of closing out market’s position.

Market risks

In most circumstances, risks normally change the market prices such as interest rates and currency risks. Interest rates and currency risks usually affect the income and value of the firm. The main goal of managing risks is to administer and control the exposure in terms of market risks in the suitable parameters while at the same time maximize the returns (Gorrod 2004, p. 56). Most of these firms operate globally.

This leads to exposure of various firms to currency risks emanating from several currency exposures, mainly with regard to the Euro and the US dollar. Currency risks generally emanate from future business transactions, recognized liabilities and assets, unrecognized company commitments, as well as the net investments in the foreign operations (Crockford 1986, p. 63).

Risk management techniques used by Wal-Mart, De La Rue, Marks and Spencer Group Plc (M&S), Tesco Plc and BT Group Plc

Wal-Mart

Being the largest public corporation in the world, Wal-Mart is a multinational retailer company that deals with chains of warehouses, stores, as well as large discount departmental stores. With its headquarters in Arkansas, the company is ranked as the largest retailer in the world.

Similar to other multinational companies, Wal-Mart also faces diverse number of financial risks. The firm’s management attempts to mitigate these risks using various techniques.

Currency risk

Apart from its operational units in the US, Wal-Mart operates in 16 other countries. The firm has the highest number of operational units in Canada, Mexico, Brazil, Japan, the UK and the US. In Brazil, there are 403 retail segments and 76 wholesale units. In Canada, there are 325 retailing units. China has 371 retailers in addition to1256 retailers and 108 wholesalers.

Having its enterprises outside the US has put most of its revenues at risk. The Canadian dollar usually fluctuates against the US dollar. Fluctuations associated with the Japanese yen, the sterling pound, the Canadian dollar, and other foreign currencies, particularly in countries where Wal-Mart has its business segments, on average put Wal-Mart’s revenue at risk.

Depreciation of foreign currencies leads to unanticipated decline in revenues from foreign investments. This is normally the case where Wal-Mart wishes to repatriate profits back to its home country.

In order to mitigate risks associated with the depreciation of foreign currencies, Wal-Mart chooses to reinvest profits into the foreign investments in anticipation of their growth. Their growth would lead to substantial future profits.

Interest rate risk

The firm faces interest rate risk given that it has both domestic and international loans, which are subjected to risks associated with changes in interest rates. The company’s long-term debt stood at $43,842 million in the end of the year 2011. When interest rates increase, Wal-Mart ends up paying high interest rates. This leads to high interest expenses and subsequently high cost of operating business.

Wal-Mart is employing a number of techniques in dealing with interest rate risks. Currently, the management is embracing the use of equity to raise capital for its operational activities. The company’s equity increased from 64,960 million from the year 2009 to 70,468 million in the year 2010. However, the company is also keen to avoid diluting its shares, as this will make them unattractive in the eyes of investors.

Tesco Plc

Tesco is a Multinational company that specializes in grocery and general merchandise retailing. With its headquarters based in Cheshaunt, the company has grown considerably and, today, it is ranked as the third largest retailer worldwide in terms of revenues.

It is also ranked second after Wal-Mart in terms of profits. It majorly trades its shares at the London Stock Exchange. Tesco Plc faces a number of risks at the market since its operations are not only restricted within the domestic borders. The corporation has various business units worldwide.

Credit risk

The company faces difficulties arising from credit risks. The company loses millions of pounds every year because of the default in paying short term and long term loans advanced to various individuals and businesses. In February 2009, the company did not have any uncollectible amounts written off. However, the company managed to collect 5 million pounds, which it had written off the previous year.

In the following year, the company wrote off an amount worth 6 million that was deemed uncollectible. Nevertheless, this year, the company has not yet recorded any recoveries from the previous period. This indicates that the firm faces credit risk given that most of the debtors fails to pay most of their obligations when the time is due. This could jeopardize the firm’s operation in future.

The management has come up with various measures that are focused on reducing the level of losses resulting from defaulting debtors.

The company has decided that it will only extend advances and loans to institutions that have high chances of repaying the short term and the long term loans as per the information provided by several credit rating agencies such as the S&P 500 index. In fact, the management has decided that only companies with a credit rating of Abb would be given various advances and loans.

Currency risk

The company has various operational units in several countries in Europe, Asia and America. It has over 2500 stores in the world. Most of the revenues that are earned in foreign countries are repatriated back to the UK. Given that there are always fluctuations in the exchange rate, the company is subjected to potential losses arising from the fall in the value of foreign currencies.

The company has also foreign loans, which it finances. If the value of foreign currency rises, Tesco Plc would face high interest expense as it regards to the financing of loans. In the year 2009, the company made translations of foreign currencies worth 44 million pounds for which there was a charge amounting to 5 million pounds.

In the year 2010, the company made translations of foreign currencies worth 47 million pounds. In 2010, the company was charged 5 million pounds for translations made in the same year.

De La Rue

De La Rue Plc is a British company that deals with papermaking, security printing, as well as cash handling. With its headquarters based in Hampshire, the company trades its shares in London Stock Exchange. The company has facilities in various regions such as Gateshead, Essex and Somerset.

The company has remained a partner of central banks, commercial organizations and governments due to its effectiveness in the printing industry.

Interest risk

The company is currently facing interest risks given that most of its assets are in the form of debts. This implies that alteration of the interest rate may negatively affect De La Rue Plc. The company’s domestic debt stood at 44.9 million pounds in the year 2010. However, the amount reduced to 12.8 million pounds in the following year. The debt in the US dollars stood at 17.0 million pounds in the year 2010 while, in the year 2011, the amount increased considerably to 21.1 million pounds.

The Euro debt reduced its profits by great margin given that the amount reduced from 9.1 million pounds in the year 2010 to 3.5 million pounds in the year 2011. However, other foreign debts increased from 6.3 million pounds to 31.2 million pounds.

This indicates that the company still has high amounts of debts associated with the US dollar and other foreign currencies. Increase in interest rates would mean that De La Rue Plc would have to pay high interest expenses.

The company is coming up with various measures to mitigate losses of the firm resulting from changes in interest rates. The company is currently purchasing futures ocontract. This helps a firm to lock interest at a predetermined rate.

This is because contract is made where a fixed interest is exchanged with a floating interest. This kind of hedging is safe as it involves an intermediary mainly a bank or other financial institutions.

BTG plc

BTG plc is a public limited corporation that is presently a component of the FTSE 250 Index. It trades its shares in the London Stock Exchange. The company specializes in pharmaceutical product, which targets various ailments such as cancer, critical care and other diseases.

The company is currently seeking to manufacture products that will be marketed to various hospital specialists. The company’s headquarters is based in London. The company faces a number of financial risks associated with its operations. These risks are as mentioned below.

Interest rate risk

The firm faces losses resulting from changes in the interest rates. The interest risks may be associated with both interest income and interest expenses. In the year 2009, BTG plc had an interest on borrowings amounting to 935 million pounds. In the year 2010, the interest on borrowings amounted to 886 million pounds. The year 2011 closed with interest on borrowings worth 852 million pounds.

Although this indicates a decrease in the payment of interest for the last three years, the company still faces the risk of paying high expenses resulting from unanticipated interest rate increase. Apart from the interest expense, the company also faces risk of loss associated with decrease in the level of interest rate on the interest income. In the year 2009, the company recorded an interest income of 31 million pounds.

However, the income dropped to 12 million pounds in the year 2010. The company position with regard to interest income improved significantly in the year 2011 since it recorded a total interest income of 35 million pounds. The year 2011 closed with a net finance expense of 845 million pounds.

The company is, however, employing various techniques to prevent losses. Presently, the company is involving in the purchase of options. Option contracts enable parties involved in a floating rate loan to protect themselves against an unanticipated losses occurring from changes in interest rates.

Inflation risk

The inflation risk has always resulted to various financial problems such as increase in the operational costs. The operational costs subsequently push the prices of commodities up.

This leads to difficulties in purchasing such products on the part of customers. Given that BTG has customers in Europe, there is no doubt that the debt crisis in Europe, which saw many countries face inflationary pressures resulting to low purchasing power amongst the Europeans, affected BTG’s sales. The sterling pound strengthened against the Euro making the UK products quite expensive.

The company is thinking of strategies that would help alleviate unprofitability situations resulting from low sales due to inflation. Inflation on average causes the foreign currencies to depreciate in value. The company is strategizing on expanding its operations to other countries. This means that BTG would be able to benefit from the low costs of production from countries where cost of living is quite low.

Mark and Spencer plc

M&S is a British public limited company that is based in London. This retailer has over 300 stores in about 40 foreign countries. Domestic retailers are more than 700. It retails in clothing and other food products. Its stocks are listed in LSE. Similar to other public corporations, the company faces various financial risks that in many circumstances affect its normal operation (Tapiero 2004, p. 74).

Liquidity risk

The company faces illiquidity problems considering that most of its assets are fixed. Its total fixed assets amounted to 5,702.4 million pounds in the year 2011. Compared to its current assets that were approximated at 1,641.7 million pounds in 2011, the results indicate that the company still has high level of long-term assets that would hardly meet its short obligations.

The management is employing substantial measures to ensure M&S maintains a high level of liquidity to ensure its short-term obligations are met with no difficulties. The company is specifically attempting to maintain a high level of cash and cash equivalents.

In the year 2010, the company recorded a zero cash and cash equivalents. In the year 2011, the company’s cash and cash equivalents increased to 1.6 million pounds. M&S continues to put concerted efforts to improve its liquidity position (Flyvbjerg, Bruzelius & Rothengatter 2003, p. 95).

Currency risk

The company has various segments spread in over forty countries. The company is not always sure of the exchange rate. This directly affects the earnings it repatriates back to its home country.

In order to deal with this problem, the company is considering the purchase of currency futures. This approach assures the management that the exchange rate is locked at a specified rate. The transaction date is normally specified in the contract.

Hedging activities

Most of the investors believe that the hedge accounting must be strongly associated with the management risk of the firm in order to enhance the helpfulness of the information obtained from the financial reports (Lam 2003, p. 87).

The disclosures offered on the hedge accounting today, mainly focuses on instruments used in hedging by firms instead of the firm’s activities as regards to the risk management (Rüdiger & Embrechts 2005, p. 53). As a consequence, the information disclosed by the firm on the hedge accounting report is found by investors to be of no help.

In other words, the Financial Instruments do not assist them to comprehend the activities of the firm as regards to the risk management (Kenji & Mesler 2004, p. 45). Recently, firms are providing information on how they are using the strategy to manage risks, as well as how the firms’ activities on hedge accounting affect timing, uncertainty and amount of predicted cash flows.

Furthermore, firms are keen on measuring the impact of hedge accounting on the financial reports (Horcher 2005, p. 89). Risks that are under management are those that firms are exposed to. Firms come up with various decisions to hedge such risks. This happens only if application of the hedge accounting is possible.

Conclusion

Risk evaluation allows a firm to study the risks that the company is facing. It is normally founded on a structured process that starts with risk identification followed by assessment of the possible occurrence, and finally calculating the cost of such an occurrence.

Risk assessment forms the foundation of the risk management, as well as crisis prevention. The main goal of risk management is cost minimization and value maximization. Therefore, it involves making good use of the existing resources and planning techniques.

Given that the business environment has become uncertain for most investors, it would be essential for multinational corporations to hedge their incomes against unforeseen losses. These losses normally arise from changes in various financial variables such as interest and exchange rates.

Given that Wal-Mart, De La Rue, Marks and Spencer Group Plc (M&S), Tesco Plc and BT Group Plc are multinational companies, it would be fundamental to employ various risk management techniques to protect their incomes which are exposed to various financial risks such interest and currency risks. Their sustainability in the business environment should also be preserved by ensuring their liquidity levels are strong.

List of References

Covello, V & Allen, H 1988, Seven Cardinal Rules of Risk Communication, Environmental Protection Agency, Washington.

Crockford, N 1986 An Introduction to Risk Management, Woodhead-Faulkner, London.

Dorfman, M 2007, Introduction to Risk Management and Insurance, Prentice Hall, Englewood Cliffs.

Flyvbjerg, B, Bruzelius, N & Rothengatter, W 2003, Megaprojects and Risk: An Anatomy of Ambition, Cambridge University Press, Cambridge.

Gorrod, M 2004, Risk Management Systems: Technology Trends (Finance and Capital Markets), Palgrave Macmillan, Basingstoke.

Horcher, K 2005, Essentials of financial risk management, John Wiley and Sons, New York.

Hubbard, D 2009, The Failure of Risk Management: Why It’s Broken and How to Fix It, John Wiley & Sons, New York.

Kenji, D & Mesler, M 2004, Advanced Financial Risk Management: Tools and Techniques for Integrated Credit Risk and Interest Rate Risk Management, John Wiley, New York.

Lam, J 2003, Enterprise Risk Management: From Incentives to Controls, John Wiley, New York.

Moteff, J 2005, Risk Management and Critical Infrastructure Protection: Assessing, Integrating, and Managing Threats, Vulnerabilities and Consequences, Congressional Research Service, Washington.

Rüdiger, F & Embrechts, P 2005, Quantitative risk management: concepts, techniques and tools, Princeton University Press, Princeton.

Tapiero, H 2004 Risk and Financial Management: Mathematical and Computational Methods, John Wiley & Son, New York.

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