This is a bibliographic compendium that establishes an approach to the issues that can generate a situation of risk and uncertainty in business operations. The administration of pure risk in the base entities that will treat the concepts of risk and uncertainty and their relationship, as well as the moments in which the entity is vulnerable to them.
Risk management will know its concept, stages and procedures to execute them. Financial risk management in the base entities is where coverage will be given to the study of the foreign exchange markets, the prices, the factors underlying the formation of exchange rates, the techniques in accounting and transaction risk, in addition of risk due to interest rate variation. The following work has the purpose -attention to the need to insert professionals in training and graduates in the current financial situation under its new trends, as a result of the evolution that the commercial and financial exchange has undergone- to become a study material and consultation according to teaching requirements.It also lays the foundation for achieving greater capacity in managerial decision-making in the face of the inevitable recurrence of risky events for the exercise of the base entity.
What is understood by risk?
Historical background
Risk is one of the most discussed concepts in academic and professional circles. Based on the above, it is necessary to analyze the treatment given to the same different authors:
In its etymological version, Risk was associated with the old Catalan word Recc and the ancient Occitan language resegue, basically of unknown origin. According to established assumptions, it has been suggested that it had the same origin as the Castilian Risco, translated as "steep rock", formerly Riesco, due to the danger that runs through these places.
Over time, the use of this word evolved to designate imbalanced phenomena. In the year 1300, there was a new meaning, synonymous with disagreement and division, used for the first time by Gudufre de Bullon, in a letter to the Duke of Normandy. Later, in the 17th century, Rojas Zorrilla uses it as a "contradiction or denial".
The most widely used and well-known meaning is currently defined as “danger that runs.” Consequently, risk as a phenomenon arises associated to characterize situations of danger or warning that induce moments of uncertainty. Given the characteristic that indicates the meaning of risk, in the broad sense of the word, let's analyze the concept from an economic point of view. In this sense, the phenomenon has been defined as the "Possibility of an event occurring, the probability of which may or may not be measurable".
What is meant by uncertainty?
According to the Technical Consultation on the Precautionary Approach in Fisheries (CTEP), it is the imperfection of knowledge about the states and processes of Nature. But statistically it is defined as the randomness or the error coming from various ways described when using the statistical methodology.
Types of uncertainty: Uncertainty due to measurement errors and bias (doubtful business), uncertainty in the process, uncertainty in the model, uncertainty in the estimation, uncertainty in the implementation.
On many occasions, the word risk is often identified with uncertainty; This last word that constantly appears in different places as an equivalent of risk or vice versa can be classified in three different ways:
- That uncertainty that derives from not being certain of what happened or is happening. The one that comes from the difficulty of foreseeing the future. The insecurity, doubt or insufficient knowledge that to a greater or lesser degree surrounds economic events and their results.
What is the deference between risk and uncertainty?
The difference between risk and uncertainty lies in the knowledge of the decision maker about the probability or possibility that the expected result will be obtained. That is, the risk exists when the person making the decision can calculate the probability of the event.
What elements determine this way of acting, that is, facing risk?
Let's see:
Years ago, risk was not the object of special study by some entrepreneurs, since the low industrialization, the nonexistent management instruments and the legal protection that companies were subject to, made it totally unnecessary. Therefore, the risks were either transferred to the insurance companies or simply ignored. But the increase in the number and amount of disasters, claims and events in recent years has caused insurers to no longer be able to cope with the usual market conditions.
Therefore, a greater effort on the part of the entrepreneur is necessary to mitigate the current and potential presence of the risk, either by dividing it or transmitting it to other institutions (incurring a cost) that are qualified, capable and specialized to take charge of them. In the event that the entrepreneur cannot perform these operations profitably, then he must assume them as long as the expectations in obtaining profits are greater than the chances of loss.
Therefore, the company or entity will be in a scenario where the risk acts, although it varies according to certain conditions, which is why the talent of the businessman and the staff of the different financial institutions in the search for new products and techniques, together with Knowing how to take risks will depend on the result of this effort, how?, knowing how to manage it.
It follows from the above that the process of risk analysis in its economic sense consists only of calculating probabilities. The final decision will depend on the position that the manager has in the face of risks. Lovers of risk will choose the option with the highest profitability. Those who oppose this will choose the opposite, the option that involves the fewest possible losses and perhaps the smallest gains.
However, the controversial point is to organize the bases on which the risk is to be assumed or not, for which the presence or establishment of a system of prudential supervision and risk management is necessary, which should cover all Risk scale in a way that allows the company or a financial institution to measure the risk it incurs when, for example: it grants a loan, when it carries out foreign exchange or interest operations in the financial markets.
On the other hand, risk management aims to investigate the quality, exercise and resistance of the management of a financial institution to assume these. At the same time, it determines the reasons for the items in the financial statements and analyzes trends and characteristics, delving into the causal relationships between the variables that could risk the entity's financial position. In short: in an environment with risk, the entrepreneur or manager under certain conditions will test his talent and that of the staff of financial institutions in the search for new production lines to achieve the proposed commitment, and that knowing how to manage the risk is valued its administrative capacity.
Causes of the risks
- Probability of something happening (event). That said event contains some uncertainty. Waiting for a result for an investment.
Classification of risks
1.- For the interests that affect:
- Personal: they are those that threaten the physical integrity of people. Real: they are those that affect the integrity of bodily things, whether movable or immovable. Patrimonial: they are those that imply an economic loss and not a physical one.
2.- Due to the variability of the danger:
- Constants: if the threat is presented with the same intensity over time. Progressive: they are those that in the course of days increase the danger. Decreasing: that as time passes the intensity of the threat decreases.
Types of risks: pure and financial
According to the economic consequences derived from the incident, a distinction can be made between "Pure Risks", in which there is only the possibility of loss (eg, fire risk) and "Speculative Risks", in which the subject exposed to the risk has the possibility of winning or lose (eg: stock market risk).
Pure risk management in the base entities.
Definitions
Ø The General Administration can be defined as the process of planning, organizing, directing and controlling the resources and assets of an organization in order to meet its objectives at the lowest possible cost.
Ø Risk management or management includes a broad sector of this definition, so we can argue that risk management is the process of planning, organizing, directing and controlling the resources and assets of an organization to minimize the effects of accidental losses on the organization to the minimum of possible costs. While the Financial Risk Management analyzes the risk-generating situations that occur in the financial markets for the application of techniques that maximize the possibilities of profit.
Risk management requires that decisions be formulated and made to carry out or fulfill the established objectives. A logical procedure for risk management decision making involves:
- Identify and analyze the problem. Formulate alternative decisions to the problem. Choose the best solution. Carry out the chosen solution.
A more detailed expansion of the concept of risk, once the criteria of different authors have been analyzed, can define it as follows: contingency or probability of incurring an equity loss as a result of a financial transaction or for maintaining an imbalance or position between certain assets or Passives.
Therefore, any financial transaction carries an implicit risk, but not a unique one, but in an operation of this category other types of risks will be particularly relevant.
Currency Market
- Cash: In this the price of the currency is for a quick delivery. Term: The currency is bought and sold for future delivery, usually in 1, 3 or 6 months, although in the main currencies banks are willing to buy and sell up to 10 years.
Buying a forward contract is a technique to eliminate the volatility of future cash flows caused by fluctuations in exchange rates. This technique is known as "financial protection" or "Hedging".
The forward market allows international companies to transfer exchange rate risk to professional risk takers for a price. Forward contracts can be made for any amount, for any period of time and between any two currencies as long as the two parties to the agreement agree. Some forward contracts are made directly by individuals or by companies without going through intermediaries. However, term contracts are generally negotiated between banks and their clients and are tailored according to the specific needs of each client.
Companies involved in international trade can protect themselves with futures contracts or forward contracts. When used for financial protection purposes, both instruments produce the same final result, even if one of them differs with respect to the date in which the profit or loss associated with the contract will be recognized. With a forward contract, profit or loss is recognized daily (known as a market adjustment), while profit or loss associated with a forward contract is not recognized until the actual delivery date (end contract). However, an increasing number of small companies that do not have transactions large enough for the forward market are now using the forward currency market to reduce exchange rate risk.
The currency market is the base market of all other international financial markets, since it establishes the exchange value of the currency in which the international monetary flows are to be carried out.
This market should not be confused with that of currencies, since in the currency markets what is traded is not the currency in its physical state but the currency, which is nothing more than a deposit or bank balance in a currency other than ours made in a financial institution.
Currency is considered:
- The deposit of foreign currency in a financial institution. The documents that entitle you to have these deposits (Checks, Credit cards, etc.).
A currency is said to be convertible when its price is determined by supply and demand, that is, by the market, and there are no restrictions on transactions (payments and transfers) with it or geographic discrimination. In other words, a currency is convertible when it can be freely exchanged for another.
Size of the market
The size of the foreign exchange market measured in terms of the volume of daily transactions is on average around one trillion dollars a day (1996). This figure sufficiently exceeds annual world trade and several times the world gross product.
Likewise, it is a figure that also in daily terms exceeds more than one hundred times the average daily value of the shares in the New York market. The currency market is the largest market in the world.
The most important plaza is still London, followed by the United States, Japan and Singapore. Regarding the currencies exchanged, the US dollar continues to be the leader, although it continues to lose relative importance in favor of other currencies, especially the EURO and the Japanese yen, which occupy respectively the second and third places, followed at some distance by the pound sterling. Future options and currency options have gained some weight, although not very significant.
It is estimated that approximately a third of the market is intermediate or operates through banks, with more than 3,500 participating banking entities. In London, with about 550 authorized banks, more than two thirds are foreigners.
Market participants
Forex market participants can be grouped as follows:
- Individuals: who go to banks to request the sale and purchase of foreign currency. They have little bargaining power. Companies: that act in the market to request or offer currencies derived from their international operations or transactions or to place surplus cash or seek international financing. Quasi-banks: for the purposes of the currency market. Under this name, it is intended to refer to large companies, generally multinationals, that have a large movement in foreign currency and consequently are determining factors in the formation of the market. Banks: that act on behalf of their clients and on their own account. In reality, most have limited activity in the market and tend to try to balance their purchases and sales of currencies, avoiding keeping open positions. However very few banks,generally the large ones are active in the market. These are market makers informing of the sale prices at which they are willing to operate. Brokers: their function is to put the bidders in contact with the claimants, thereby charging a commission. Their mission is to hunt down the operations of the market makers. Therefore, they do not take positions or influence the exchange rate, the price discrepancy between banks makes the market margin wider than that of any bank.Therefore, they do not take positions or influence the exchange rate, the price discrepancy between banks makes the market margin wider than that of any bank.Therefore, they do not take positions or influence the exchange rate, the price discrepancy between banks makes the market margin wider than that of any bank.
Currency Market Merchandise
From the point of view of the geographic location of the market, it has traditionally been distinguishing between the continental system and the Anglo-American system. The first consists of the specific location of the place where the currencies are traded: stock exchanges, central bank. In the Anglo-Saxon system, on the other hand, there is no specific site or place, but they work by electronic and telephone system. Transfers and clearing are done via computer. The Anglo-Saxon system is the one that has truly prevailed worldwide, to which technological advances and greater international financial and economic integration have obviously contributed.
However, in some countries such as Spain, Belgium and other Europeans, a fixing is established, a market reference rate at a specific time of day that is obtained from the interaction between representatives of commercial banks and the central bank. Generally speaking, it is a process similar to that of the Walrasian auctioneer. This auctioneer (representative of the central bank) sets the price. If there is excess supply or demand at this price, another is announced until the market cleans (supply and demand are equalized). At this price, transactions are carried out between the participants in the auction.
The currency market is an OTC (over-the-counter) market, not organized. The operating agents are actually in the offices of the main commercial banks in the world, which communicate with each other electronically, by telephone, telex and other information channels. They agree on quantities and prices and later the transactions and their details are confirmed and the operation is carried out.
By way of illustration, it has been pointed out that approximately one third of the market responds to operations channeled by fifteen banks, among which are the best known of the international banking system (Chase Maniatan, Chemical, Citibank, Barclays…). The number of banks exceeds 3,500, although the number of market-creating banks is estimated to be around 200.
The main operators and participants in the currency market have a trading or expert room (front offices), in which the contracting, the monitoring of operations, the execution of client orders and the management of trading positions are carried out. risk. The so-called back office or administrative service complements the operations room, since it deals with the confirmation of operations, the accounting, the issuance of payments and the receipt (control) of collections, as well as the monitoring and control of the positions of risk (counterparty risk).
The means of contracting are the telephone, intermediaries and brokers and the Reuters Dealing system. The payment issuance system mainly includes the telephone, mail, telex and the SWIFT system.
In 1995, 83% of the convertible currency trade was carried out in relation to the dollar and in 1989 it was 90%, that is, the rest of the currencies are largely exchanged for US dollars.
The fact that most foreign exchange trades are listed in relation to a common currency, on the one hand, reduces the complexity of the information. Indeed, if we think of fundamentally multilateral currency trading there will be a considerable number of markets and prices. Thus, for example, a multilateral market between 10 currencies implies trading at 45 prices. That is, the first currency is listed with the remaining nine, the second with the following eight, and so on.
In general, the number of bilateral exchange rates between n currencies will be n (n-1) / 2. On the other hand, the possibilities of triangular arbitrations are reduced based on price differences. That is, if the cross exchange rates of all currencies are obtained against the US dollar, then there will only be one possible cross exchange rate.
Most of the foreign exchange market operations are interbank in nature. Thus, according to data from the BIS (1990), 85% take place among market creators, so the remaining 15% may respond to commercial operations.
There are automated contracting systems that, through ordering programs, match offers and demands. Through an automated brokerage terminal, it is possible to offer international sale and purchase prices. The automated systems generally used are EBS (Electronic Broking Service), offered by Quotrom and a consortium of American and European banks; Reuter 200-2; MINES, offered by a group of Japanese banks and the broker, Dow Jones, Telerate and the Japanese telephone company.
Given the magnitude of the interbank share of the foreign exchange market, it is possible to conclude that if this segment (85%) practically "agrees" (coincides in expectations) that there is a currency that has to depreciate in relation to another and begins to sell, to get rid of it, will inevitably depreciate.
If this is so, to a certain extent it can be concluded that in the short term it may be that 85% of the market ignores the variables of foreign trade, relative prices and others and fundamentally it is day-to-day, based to a certain extent on other variables, what supports interbank activity. Obviously, sometimes and to a greater or lesser extent, interbank transactions can respond to signals from the real economy.
In the interbank market, speculation is a zero-sum game (the gains of some are offset by the losses of others), except for the effect derived from the interventions of central banks. The interbank market may yield net profits or losses that correspond to the net profits or losses of central banks.
When the quantity purchased exceeds the quantity sold, a long position is said to have been adopted, while a short position occurs when the quantity sold exceeds the quantity purchased.
Interest rate parity theory
Also based on the idea of equivalence, it assumes that the returns that can be obtained from investments in two different countries must be the same. This can only be analyzed accurately in the absence of risk and for it to be totally eliminated, it will be necessary to resort to buying or selling the currency in term, which ensures a certain exchange rate when recovering the interest obtained from the investment.
Example
Suppose a German investor borrows at his country's nominal interest rate (8%) 12,500.00 marks for a one-year term, at the end of which he must return a total of 13,500.00 marks. He changes this for pesetas at the exchange rate of 80 pts / m, for which he receives one million pesetas that he deposits for one year at the nominal interest rate in force in Spain (12%). After a year, he will receive a total of 1.1 million pesetas, which he will change again by Marcos at an exchange rate equal to the forward rate. In efficiency, this will result from the following calculation:
If = (ia - ib) / (1 + ib) = (0.1 - 0.08) / (1.08) = 1,852%
Tf = To * (1 + if) = 80 pts. / m * 1.01852 = 81.48 pts / m
With this exchange rate, when you distribute your income, you will receive practically the same thing that you must return to your German creditors, with which you will not have obtained any advantage in such an operation.
Exchange rate expectations theory
It assumes that the expected spot rates within t periods coincide in the future with the current forward exchange rates at periods. As long as these two rates are referred to the same period of time, with To being the same for both, we must deduce that:
Tf = Tt
If investors take risk into account, then the forward rate may be higher or lower than the expected spot rate. Suppose that a Spanish exporter is sure to receive a million marks in 6 months, he can wait until that time and then convert the marks into pesetas, or he can sell the marks in installments. To avoid exchange risk, the exporter may wish to pay an amount slightly different from the expected cash price. On the other hand, there will be entrepreneurs who want to purchase forward frames and, in order to avoid the risk associated with changes in exchange rates, are willing to pay a forward price somewhat higher than the cash price they expect to exist in the future. future.
Term Rate Expectations Theory
If risk is not taken into account, the current rate and the anticipated rate are strongly influenced by current expectations about what will happen in the future. In other words, if the one-year FS forward rate is FS 1,445 / USD, it can only be because the spot rate within one year is expected to be FS 1,445 / USD.
Example
eFS = 1.50 fFS = 1.455
If E (eFS) = 1.43 ® Buy term FS
¯
+ demand FS Þ fFS
If E (eFS) = 1.45 ® Sell term FS
¯
+ offer FS Þ fFS ¯
Equilibrium is reached when the difference between the exchange rates in the current market and the anticipated market equals the difference between the current exchange rate at the time of listing and the expected current exchange rate for the future date corresponding to the rate. of early change.
Purchasing power parity theory
- Single price law.
The Single Price Law states that a merchandise will be sold for the same price regardless of where it is purchased. In general terms, for a single good:
PX = PUSD * eX / USD
Where: PX.- Price of the product in a foreign country.
PUSD.- Product price in the USA.
eX / USD.- Exchange rate of the foreign currency for USD.
If it is cheaper to buy wheat in Argentina than from a US producer, after transportation costs and adjusting the price of Argentina with the exchange rate, a rational US customer will buy (import) Argentine wheat. This results in an increase in the demand for Argentine wheat, which in turn means:
a) The price of Argentine wheat will rise in relation to that of the USA.
b) The Argentine austral will be strengthened until PARA = PUSD * eARA / US
In other words:
Goods that can be bought cheaper abroad will be imported, and this will force down the prices of the domestic product. In the same way, those goods that can be bought cheaper in the national market will be exported and forced to lower the price of the product abroad.
In our example, the prices of goods in Argentina, when expressed in dollars, should be almost equal to the prices of those same goods in the United States.
- Purchasing Power Parity (PPA).
Based on the Single Price Law, PPP means that the exchange rate between the currencies of two countries is directly related to the differential rate of inflation between them. Any movement in the differential inflation rate is offset by an opposite movement in the spot exchange rate.
Bibliography
De la Oliva F. Separata on the International Financial Administration of the Company (in preparation).
Ravelo Nariño A. International Business Financial Administration.
Shapiro AC Multinational Financial Management, 4th edition, Allan and Bacon Publishing, Boston 1991.
Fundamentals of Business Financing.
Fundamentals of Financial Administration.
Financial engineering. Management in international financial markets.
