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2 most common financial risks faced by a company
| 16-6-2017 | Victor Macrae | treasuryXL |
An important task of a treasurer is to fully understand the financial risks that impact the firm. Two risks faced by most companies are interest rate risk and foreign exchange risk. Both risks can negatively impact the firm’s financial statements and can ultimately even lead to bankruptcy!
Interest rate risk
Interest rate risk originates from interest bearing liabilities. Most firms have loans. In the case the interest rate is variable, the interest paid varies according to an agreed market rate, such as Euribor or Libor. The risk is that the market rate will increase to a level where the firm is not able to pay its interest payments any more. In that case the firm is in default and theoretically the loan provider can request full loan redemption. In practice the loan provider is now in charge and will increase the margins on the loan as a result of the higher counterparty risk and also other charges such as fees of lawyers will be due. In order to mitigate interest rate risk a firm can use fixed rate loans or use variable rate loans in combination with interest rate derivatives such as interest rate swaps or options.
Foreign exchange risk
Foreign exchange risk occurs when a firm has subsidiaries abroad or when it transacts in a foreign currency. Suppose a firm with the euro as home currency sells products in Japanese Yen (JPY). Payment is due in three months’ time. If the JPY has weakened against the euro with 20% when the payment is due after three months, the revenues in euro are 20% lower. If the margin on the sales was 15%, then the negative foreign exchange rate change has led to a loss of 5%. Foreign exchange rate risk can be mitigated by various means, such a moving production to countries where the firm sell its products in order to match the currency of cash in- and outflows. Furthermore, derivatives such as forwards or options can be used to mitigate foreign exchange risk.
3 steps
The first step in managing interest rate risk and foreign exchange risk is to examine how the firm is exposed to these risks. The second step is to measure the impact of the volatility of interest and currency rates to which the firm is exposed on its financial statements. In the third step, if the effects are serious, the treasurer should consider which of the available options for risk mitigation best suits the firm.
Victor Macrae
Owner of Macrae Finance
How to get a fair deal on your derivatives trades
| 15-6-2017 | Simon Knappstein | treasuryXL
We discovered the article ‘Are you getting a fair deal on your derivatives trades” on treasurytoday. In the article derivatives are described as a good tool to mitigate risk and protect the company’s financials from moves in the market. However, derivatives come at a cost and often these costs are also hidden, which means that the treasurer cannot be sure that he is getting a fair deal.
Price of the deal
Greater transparency is needed and that was the reason why company NEXTrioptima developed its triCalculate solution. When treasurers execute a deal with a bank they typically cannot see how the price of the deal is calculated and what the bank is charging them for credit risk.The tool triCalculate tries to change this by taking the corporate’s derivatives trade file, a credit curve file and a credit support annex (CSA) file (where one exists) and running these through a series of highly complex mathematical simulations. The result: an accurate XVA calculation that enables corporates to quickly identify and price the impact of a counterparty default and the cost of funding a derivative portfolio. This is the first Software as a Service (SAAS) on the market. The tool does not only provide companies with greater transparency over their current derivative portfolio, but also offers the chance to plan new deals much better.
We asked our expert Simon Knappstein if this tool is really worth the while.
All the capital a derivative trade consumes, or is expected to consume, over its lifetime is increasingly incorporated in the price of a trade. CVA, a valuation adjustment for counterparty credit risk was initially the major adjustment, soon to be followed by FVA (funding value adjustment) and many related adjustments that go under the umbrella name XVA. Properly calculating these adjustments for every trade on a portfolio basis is difficult and time consuming. So the new product offering TriCalculate by NEX TriOptima looks like a promising tool for corporate treasurers to help them gain insight in the pricing process of derivatives offered by their bank. By the way, being able to calculate a fair value on a potential trade does not guarantee you a fair deal, but it will certainly help.
Simon Knappstein
Owner of FX Prospect
More articles of this author:
FX global code of conduct
Negatieve interest rate policy: No lasting effect on FX
PSD2 is coming soon: Some information about PSD2 summed up
| 14-6-2017 | Mark van de Griendt | PowertoPay |
PSD2
With the coming of PSD2, banks are obligated to provide these (selected) third-party providers access to their customers’ accounts through open API’s. This will enable third-parties to create financial services on top of the banks relation data or banks’ infrastructure.
Banks get a different role and since these third-party companies can now be their competition, banks are working together with these FinTech companies. PSD2 will fundamentally change the order to cash value chain, what business models are profitable, and customer expectations. Through the directive, the European Commission aims to improve innovation, reinforce consumer protection and improve the security of internet payments and account access within the EU and EEA.
For banks, PSD2 might possess substantial business challenges. IT costs will increase dramatically due to new security requirements and the opening of API’s. And, as FinTech’s take over the customer interaction, banks may find it increasingly difficult to differentiate themselves in the market for offering loans. The first business cases show us successful new products for renewed loan offerings based on actual data, PSD2 will boost product development, end-users will take advance of new market propositions.
What exactly will PSD2 bring?
Sources:
SEPA for corporates
Evry
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