Financial risk management encompasses corporate strategies of employing financial transactions to eliminate or reduce measurable risks. Most businesses face financial risks of some sort, such as currency price volatility, interest rate changes, commodity price fluctuations, or from some other source.
A key attribute of a financial risk is that it can be managed by entering into some form of contract that can be settled in cash. Classic forms of contracts with these characteristics include forward contracts privately arranged between two parties or futures contracts traded on exchanges located around the world. Exhibit 18.1 includes an overview of some of the types of contracts traded at several of the largest futures exchanges in the United States. As may be seen from the wide array of contract types and underlying assets, futures markets exist to manage risks as disparate as those arising from the stock market (i.e., S&P 500) to the amount of snowfall in Boston or New York City.
Financial risk management strategies, often called financial “hedging,” can be considered as a predecessor in the evolution of enterprise risk management (ERM) programs. ERM addresses a far broader array of risks than those that can easily be hedged using financial contracts. However, hedging of financial risk by firms around ...