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With interest rates remaining low, many companies that have stockpiled large amounts of cash are now looking to put that capital to work by expanding their businesses. Much of this growth will be achieved through strategic transactions, such as acquisitions, rather than organic growth – which inevitably impacts risk management.
A fundamental rule of risk management is that the company’s risk management policy must be aligned with its overall business strategy. The degree to which a company can accept exposure to fluctuations in the financial markets is largely determined by the risk profile of the company itself. In other words, a stable business with revenues which are unaffected by economic cycles or the activities of its competitors is likely to have a greater risk appetite than a more volatile business.
This relationship is important in the context of growth because strategic activities such as acquisitions can have a profound impact on a company’s risk profile. Accordingly, if a company’s business strategy changes, its risk management policy must also be revisited.
As a business embarks on a strategic path, it should focus on three key priorities. The first is protecting the company’s buying power, whether this comes in the form of cash balances or secured bank lines. Secondly, once a target has been identified, the company needs to hedge the transaction so that it continues to make financial sense regardless of market movements. The third priority is to ensure the best use of risk management instrumentation. When companies make hedging decisions, it is often tempting to use the simplest possible instruments, such as forwards or cross currency swaps. However, the use of these instruments can lock companies into particular interest or FX rates.
All too often risk management is perceived to be synonymous with hedging, but hedging is only a part of managing risk. More important is gaining an understanding of how much financial risk a company is facing due to movements in the financial markets – and how much of that uncertainty the company should be willing to accept.
The risk management decisions that are made today need to be appropriate
for the company now and in years to come. Funding decisions, therefore,
should be made on the basis of new risk management requirements, rather
than focusing solely on today’s balance sheet.
As companies look to grow, they should align risk management
decisions with the business strategy, adjust risk policy in light of
strategic events – and resist the temptation to become over-hedged when
it may compromise their competitiveness in a favourable market.
Consequently, if the markets move in the company’s favour when it has
protected itself with forwards, it may find itself at a disadvantage in
comparison to competitors that haven’t hedged at all, or are hedging
using option-based strategies. It’s crucial that companies consider
whether the benefits of paying for options may outweigh factors such as
premium costs and accounting treatment.
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Longview Winter 2011-2012, 25/01/2012