Risk Management Must Know Facts
Post on 27,December 2012   4:00 PM
By - Mr. Sanjay Kumar
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An effective manager should be aware of the various financial instruments available in the market for managing financial risks. There are many tools for the same and a judicious mix of various tools helps in efficient risk management.

Since the early 1970s, the world has witnessed dramatic increases in the volatility of interest rates, exchange rates and commodity prices. This is fuelled by increasing internationalization of trade and integration of the world economy, largely due to technological innovations. The risks ar ising out of this internationalization are significant. They have the capacity to make or break not only businesses but also the economies of nations. However, financial institutions are now equipped with tools and techniques that can be used to measure and manage such financial risks.The most powerful instruments among them are derivatives.

Derivatives are financial instruments that are used as risk management tools. They help in transferring risk from the risk averse to the risk taker.

Types of Traders in the Derivatives Markets

One of the reasons for the success of financial markets is the presence of different types of traders who add a great deal of liquidity to the market. Suppliers of liquidity provide an opportunity for others to trade, at a price. The traders in the d erivatives markets are classified into three broad types, viz. hedgers, speculators and arbitrageurs, depending on the purpose for which the parties enter into the contracts.


Hedgers trade with an objective to minimize the risk in trading or holding the underlying securities. Hedgers willingly bear some costs in order to achieve protection against unfavorable price changes.


Speculators use derivatives to bet on the future direction of the markets. They take calculated risks but the objective is to gain when the prices move as per their expectation. Based on the duration for which speculators hold a position they are further be classified as scalpers (very short time, may be defined in minutes), day traders (one trading day) and position traders (for a long period may be a week, a month or a year).


Arbitrageurs try to make risk-less profit by simultaneously entering into transactions in two or more markets or two or more contracts. They profit from market inefficiencies by making simultaneous trades that offset each other thereby making their positions risk-free. For example, they try to benefit from difference in currency rates in two different markets. They also try to profit from taking a position in the cash market and the futures market.




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