Financial Risk management
The banker (portfolio manager) normally attempts to increase the value of the portfolio of investment subject to instruction that imposes various constraints on the banker. Financial Risk management is very much concerned about the difference between the values of the portfolio of assets and the liabilities which are associated with this portfolio of assets.
The main advantage of central Risk management is the absence of the conflict of interest. Central Risk management is not extracted through market. Each business is seen by different ways. Independence fails in financial risk management just because of when banker takes a higher risk in order to get personal gain. When an individual takes a risk more than risk appetite of the company it results in independence fails.
Financial risk management is all about identification, quantifying and management of the risk that the organization faces. It is not possible to eliminate risk but by performing effective financial risk management, organization can reduce the risk to the acceptable level. Every organization has risk appetite, and remaining within the risk appetite, the portfolio of manager of the organization make investments (financial times, n.d.).
Financial Risk Management
The confusion always exists between trader and the banker. The objective of the trader is to make banker conduct transaction for trading so as to get commission on every transaction. It increases the conflict of interest because whether investment in asset is risky or not the trade will persuade the banker in order to make investment.
The objective of the banker is to maximize the value of company’s portfolio of investment that is why he considers all possible outcomes and remain overcautious about risk management. Trader normally prefers riskiest asset even though this selection could lead to destroying value of the portfolio of the investment.
By using this model we can see risk management failure and confusion about bankers and traders. First we can see the increase confusion in the choices of the two assets of trader results in inappropriate selection of the asset for investment. The pressure on the trade poses the trader in a situation where he is asked to increase the PNL and it results in prevention of risk management from performing effectively.
If trader prefers risky asset to banker then increase in risk of assets traded results in reduction of the positive impact of risk management independence. Since trader gives preference to risky assets, trader becomes more biased towards risky assets. It creates confusion between trader and banker for choosing appropriate asset for investment.
By performing hedging, financial professionals can meet the number of risk management objectives such as they can decrease volatility of cash flows, the can offset interest rate fluctuations to minimize price risk and default risk etc. (amazon, n.d.).
Hedging
In order to protect for volatility of the price of assets, in which investment has been made, the banker carry out hedging techniques. The hedging assists bankers in minimizing expected loss. The banker attempts to go towards forward rate agreement and options in order to hedge its investment the trader who provides options and forward rate agreement to banker will seek for providing higher number of options. The confusion between banker and trader would remain exist because if options become favorable to banker then he is going to exercise that option and it results in loss to trader who provided option.
Nonetheless, Trader could protect himself through delta hedging. Delta hedging from the perspective of the writer of the option is neutral. Banker can provide the expected loss that could happen to the portfolio of investment by using Value at risk.
Creation of Income
The confusion between banker and trader exists because the objective of the banker differs the objective of the trader. The confusion of creation of wealth between banker and trader is to banker create wealth by making secured investments and less risky in which volatility of the prices is low. However, the trader always persuades the banker for making investment in assets whether it is risky or not. Since trader earns commission on the each transaction conducted by banker. This is what confusion remain between banker and trader with respect to financial risk management.
Failure of the Financial Risk management
The risk management function has been gained attention due to the recent market turmoil. Due to failure of Risk management in recent marker turmoil, traders are trying to protect themselves for rare events. In the period that led to market turmoil, the financial risk management has failed to perform its function...............
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