This paper investigates the use of derivatives in Risk Management. Deriving the value from an underlying asset or an index representing assets, derivatives bear the ability to accelerate gains or losses for a small initial outlay thus assisting corporations to manage risk and return opportunities, while adding value to their operations.
Keywords: risk, forwards, futures, options, hedging, speculation, arbitrage.
[...] This changed the concept of Risk Management radically, making it increasingly important. Focusing on matters of insurance, Risk Management aims to identify potential risks that may be serious potential threats to the organization. Modern organizations use Risk Management as a common practice, particularly for any operation, which is related to financial or facilities management. However, Risk Management is not focused only on financial risks, but on a multitude of risks that may pose potential threats for the organization. In particular, some of the risks, which need to be alleviated or managed by Risk Management, are: Financial risks They are related to financial transactions. [...]
[...] Deriving the value from an underlying asset or an index representing assets, derivatives create a wide range or risk and return opportunities for investors. A derivative can be defined as a financial instrument, whose value is derived from the values of other underlying variables, which, in most cases, are the prices of the traded asset (Hull, 2006). Derivatives are traded since 1848 on the Chicago Board of trade (CBOT, www.cbot.com) to bring farmers and merchants together and standardize the quality and quantity of the goods exchanged. [...]
[...] On the other hand, selling an option offers a limited opportunity for gaining the option premium if the option expires worthless, and the risk of unlimited losses, which depends on how much the strike price and the price of the underlying asset diverge Examples of using Derivatives to leverage risk Forwards, futures and options are used in a variety of ways from individual investors, but also from corporations. The main reason why derivatives markets are so attractive is because they attract different types of traders and have high liquidity. [...]
[...] In the extremely volatile financial environment of today, Risk Management focuses on matters of insurance and is concerned with identifying potential risks, which may have a severe impact on the organization Firms conduct Risk Management assessments in an effort to identify new ways of protecting theirs assets against sharp fluctuations. In this context, the introduction of derivatives as financial instruments that improve financial performance has become increasingly important. Forwards, futures and options are used in a variety of ways from individual investors, but also from corporations. [...]
[...] In some instances, risk managers may reduce the probability of occurrence by taking appropriate risk measures. For example, to anticipate the demolition of property by fire, the firm may use fire-resistant materials in areas with the greatest fire potential. In other cases, a firm may discontinue a product or a service line if the risks associated outweigh the returns. Exploring Derivatives and their use to risk leverage A major development of financial markets has been the creation and growth of new markets and instruments beyond stocks and bonds. [...]
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