RM - FINALS

• Financial risk management


  it is the practice of identifying, analyzing, and mitigating the risks that could impact an organization's financial health. This includes a variety of risks such as market risk, credit risk, liquidity risk, and operational risk.
• Market risk


  it involves changes in market prices, such as interest rates, stock prices, or foreign exchange rates, which could affect an organization’s assets or liabilities.
• Credit risk


  it refers to the potential that a borrower will default on any type of debt by failing to make required payments.
• Liquidity risk


  it is the risk that an entity will not be able to meet its short-term financial obligations when they come due because it cannot convert assets to cash quickly enough.
• Operational risk


  it is related to failures in internal processes, people, and systems, or from external events (this includes legal risks but excludes strategic and reputational risks).
• Financial risk management 


  it involves using financial instruments like derivatives to hedge or mitigate risk, alongside traditional risk management strategies such as diversification, effective internal controls, and continuous monitoring.
• derivatives


  refers to a type of financial contract whose value is dependent on an underlying asset, group of assets, or benchmark. The primary purposes of using it are for hedging risk, speculating on the future price of an asset, and arbitrage opportunities.
• underlying asset


  is a fundamental financial instrument upon which derivatives such as futures, options, swaps, and forwards are based. The value of the derivative is directly related to the value of this.
• stocks


  Individual company shares that are traded on stock exchanges. Derivatives might be used to speculate on the future price movements of these stocks or to hedge against potential losses.
• bonds


  Debt investments whereby an investor loans money to an entity that borrows the funds for a defined period of time at a fixed interest rate.
• commodities


  Basic goods used in commerce that are interchangeable with other goods of the same type, such as oil, gold, or wheat
• currency


  Money in any form when in actual use or circulation as a medium of exchange, especially circulating banknotes and coins.
• interest rate


  The amount charged, expressed as a percentage of principal, by a lender to a borrower for the use of assets.
• Types of derivatives:

  • futures
  • options
  • forwards
  • swaps
• A futures contract is a standardized agreement to buy or sell the underlying commodity or financial instrument at a specific price on a specific future date.
• An option gives the buyer the right, but not the obligation, to buy (call option) or sell (put option) an underlying asset at a specified price, within a specified time frame.
• Similar to futures, forwards are agreements to buy or sell an asset at a set price at a future date, but they are not standardized or traded on an exchange. They are private agreements between parties.
• Swaps are contracts through which two parties exchange financial instruments, such as cash flows or different financial assets.
• diversification


  is a risk management strategy that involves spreading investments across various financial assets, industries, and other categories to reduce exposure to any single asset or risk. The underlying principle of it is that different assets often perform differently under various market conditions.
• financial risk


  it arises through countless transactions of a financial nature, including sales and purchases, investments and loans, and various other business activities. It can arise as a result of legal transactions, new projects, mergers and acquisitions, debt financing, the energy component of costs, or through the activities of management, stakeholders, competitors, foreign governments, or weather.
• Interest Rates 


  it is set by central banks, and perhaps the most direct influencers of financial rates and prices. They affect the cost of borrowing money, the return on savings, and are a key tool for monetary policy.
• An interest rate is the percentage charged on the total amount of borrowed money or paid on deposited funds. Essentially, it is the cost of borrowing money or the reward for saving and lending money.
• Inflation 


  it measures the rate at which the general level of prices for goods and services is rising.
• economic indicators


  Indicators such as GDP growth, unemployment rates, and consumer spending reflect the overall health of an economy and influence market confidence and financial rates.
• government policies


  Fiscal policies (like taxation and government spending) and monetary policies (like interest rate adjustments) significantly affect financial markets.
• Expected Levels of Inflation


  it refer to the anticipated rate at which the general price level of goods and services will rise over a future period. This expectation can significantly influence economic decisions by consumers, businesses, and investors.
• Higher interest rates can lead to higher costs of holding or financing commodity investments, which can decrease demand and lower prices.
• Exchange Rate


  Commodities are often priced in U.S. dollars. If the dollar strengthens, commodities become more expensive in other currencies, potentially reducing demand and lowering prices. Conversely, a weaker dollar can make commodities cheaper for foreign buyers, increasing demand and pushing prices up.
• Higher production costs (due to labor costs, equipment costs, or regulatory costs) can lead to higher commodity prices as producers pass these costs onto consumers.
• If a cheaper or more efficient substitute for a commodity becomes available, demand for the original commodity may decrease, leading to lower prices.
• Interest rate risk 


  it refers to the potential for losses that investors can face due to changes in interest rates. It primarily affects investments like bonds and loans, where the value is closely tied to interest rates.
• Interest Rate Swaps


  This is a common derivative used to manage interest rate exposures. Essentially, two parties exchange interest rate payments on a specified principal amount. This can be used to swap from a variable rate to a fixed rate, or vice versa, depending on your risk exposure.
• Diversification


  By diversifying investments into different types of assets, some of which may be less sensitive to interest rates, you can reduce the overall risk to the portfolio.
• Fixed Rate Borrowing


  If interest rates are low, locking in rates through fixed-rate borrowing can protect against future rate increases. This is particularly relevant for managing long-term debt.
• A Forward Rate Agreement is an agreement between two parties to exchange payments usually equal to short term underlying interest rate obligations of those two parties.
• The notional principal amount of an FRA is used to calculate the interest payment only and is not exchanged.
• Forward Rate Agreement


  This is typically pronounced as "Three Nines" and it means that it starts three months after the deal date and ends nine months after the deal date, covering a six-month period (from 3 months to 9 months). The term "3 x 9" refers to the period between the settlement date and the expiry date.
• Interest rate futures are financial contracts that speculate on the direction of interest rates. These futures are based on an underlying security, which is typically a government bond or a treasury bill, and they trade on a futures exchange.
• Investors use interest rate futures to hedge against changes in interest rates or to speculate on future movements.
• Foreign exchange risk


  it is also known as currency risk or FX risk, arises from the change in price of one currency against another.