US future markets and risk management Essay Example | Topics and Well Written Essays - 2500 words

US future markets and risk management - Essay Example The aim of this paper is to examine futures as risk management techniques companies could use to manage their risks. The paper first of all examines the risks companies are prune too before analyzing how the risks can be solved with futures.Today, bankers are increasingly becoming conscious about recent developments in their respective markets and have resorted into various method of managing risk in bank. Risk management appears to have improved in most sub-regions as a result of the introduction of new approaches in conducting business as well as better measurement and pricing of the various risks (BIS Paper No 33, 2005).According to BIS paper No.33, financial markets are subject to various sources of risk: credit, market, liquidity, operational and legal risks. These risks tend to be more pronounced in the developing world than in developed countries due to a lower level of economic, financial and institutional development.Credit risk tends to be more acute as a result of a lack o f highly rated counterparties. Market and liquidity risks are higher due to thinly traded markets. Operational risks may also be exacerbated because of inadequate human resources or the failure of manual, mechanical or electronic systems to process payments. Finally, legal risk may also be part of the environment (for instance, due to the inability to foreclose on collateral). The next section discusses credit risk and some of its components and how it can be managed.The aim of this paper is to examine futures as risk management techniques companies could use to manage their risks. ... dit risk; this is typically the most important form of risk for commercial banks Shapiro, 2003; Buckley, 1996; Muller and Verschoor, 2005; Solt and Wayne, 2001).Solt & Wayne (2001) argues that, in assessing credit risk, an institution needs to consider three issues: default probabilities over the horizon of the obligation, credit exposure (ie how large the obligation is when the default occurs) and the recovery rate (ie what part of the exposure may be recovered through bankruptcy proceedings or some other form of settlement) (Solt and Wayne, 2001). Credit risk is often difficult to assess due to the lack of information on the credit history and financial position of borrowers, inadequate accounting practices and standards that make it difficult to evaluate credit exposures, macroeconomic volatility and deficiencies in the institutional environment (e.g., political instability) (BIS Paper No.33, 2005). Weak enforcement of creditor rights may also contribute to uncertainty regarding recovery rates. Although many of these factors have been improving in recent years, progress in some cases is slow (Mohanty et al., (2006). Moreno (2006) highlights two key issues related to credit risk that are relevant for emerging market economies (EMEs). First, the distinct increase in the share of credit to the household sector that has been observed in a number of countries could lower credit risk if the concentration of bank assets fell, if consumer credit diversifies risk among a larger number of borrowers. 2.0 Risk Management In management of credit risk, I will focus only on the currency risk exposure aspect of credit risk. That is in a situation where credit is offered in multiple denominations of currency. Currency risk or foreign exchange exposure or better still foreign