Due to the increasing globalization and international interdependence of many companies, currency hedging often crosses not only national borders but also the thresholds of their own currency area. In addition, the number of bankruptcies has increased enormously since then. While almost 9,000 companies went bankrupt in 1991, the number more than tripled in 2019 to around 300,000 before the global pandemic crises.
This considerable increase in foreign trade relations and the rise in the number of bankruptcies confirm the need for established risk management in companies. SMEs also have an option to outsource quantitative risk assessment services to a third party.
In the present work, an overview of the risk management system and the currency risk is to be given. First of all, the individual types of risk are explained. The third chapter then explains the objectives of risk management. It also shows how risk management operates in the individual sub-areas. In doing so, not only derivative financial instruments are considered, but also internal company measures. The choice of the instruments in this thesis was based on the ease of implementation and the frequency of the hedging instruments used in practice. Derivatives such as currency swaps, currency forwards, and futures are interpreted in their simplest form and illustrated with examples.
The term risk is perceived differently by the subjective perception of each individual. Risk-averse personalities are more critical of potential risks than risk-averse characters. Therefore, the term risk is used differently in economics.
In the following article, the areas of strategic risk, operational risk, and financial risk are explained.
The strategic risk corresponds roughly to the risks of the environment. These include, for example, technology, collaborations, and changes in the law. The energy transition is a good example of strategic risk.
Operational risks, which are called 3-P-Risks, mean process, politics, and people. Process means process risk that can arise in the individual steps. Politics is seen as an umbrella term which, in addition to political risks such as new laws or taxes, also includes natural disasters such as earthquakes or floods. People are to be understood as the risk caused by humans, which is dealt with in the context of corporate governance.
Financial risks are risks that can negatively affect the value of individual balance sheet items. These include the market risk, the liquidity risk, and the default risk. In addition, currency risk plays a major role in financial transactions, in connection with types and hedging options.
The term risk management consists of the words risk and management. Basically, this can be understood to mean managing potential deviations from expectations. In risk management, the potential risks are first recorded. Then, using appropriate hedging instruments, an attempt is made to perceive these risks as opportunities and to control them in such a way that the deviations from expectations are not negative.
Risk management is the task of corporate management, which, depending on the time horizon, can be characterized as strategic or operational control parameters. 12th risk management consists of the so-called risk management system.
The core objectives of risk management are to secure livelihoods, secure future success, and reduce risk costs. The goals of risk management must not be viewed separately from the corporate goals, but as a kind of supporting area, because otherwise competing goals are disregarded.
Examples of this are the goals of shareholder profit maximization and risk management to minimize risk. Since the two goals are in conflict, it is unlikely that they will be achieved. For this reason, management has to compromise on goals, in which the weighting of the individual goals depends on the corporate culture and corporate strategy.
The need to build up and establish a risk management system in the company is not only there to present information to the management level about the company’s financial position and the need for security, but also to comply with certain legal requirements. There is a large number of different framework conditions for this which the legislator prescribes. Some of these are explained in more detail below. Five important key statements of legal guidelines are given below:
The first pillar specifies the minimum capital requirements for market risk, credit default risk, and operational risk. As a benchmark, the regulation specifies an eight percent minimum equity ratio for the risk position, which can be determined using the solvency coefficient.
The second pillar regulates the supervisory review, which states that banks should conduct risk management that determines the risk profile of the equity capital and maintains the equity level. In addition, the supervisory authorities should evaluate the company’s internal procedures and strategies and intervene if they are not satisfied with the results of the process. The third pillar includes the publication of the risk assessment methods and capital resources of the credit institutions.20th
The risk management system consists of the three essential components of the risk strategy, risk controlling and risk optimization. The figure shows the cycle of the system as any calculable risk goes through these steps. The risk strategy specifies how to deal with the risk, the risk appetite, and the framework for the organizational implementation. Risk controlling includes the identification, assessment, and monitoring of the occurring risks, while risk optimization optimizes both pre-damage and post-damage.
When processing the next risk, the risk strategy is started again. Then the individual areas of the risk management system switch on again to identify and neutralize the new risk.
In the risk strategy, the company must determine how high its own risk appetite is, whereby the willingness to take risks can be derived from the corporate goals and corporate culture. 25 Risk-bearing capacity, risk preference, and organizational implementation are the individual steps that are carried out in the risk strategy.
After the risk strategy has been clarified, the area of responsibility for risk controlling must be dealt with. The risk strategy stipulated the company’s internal conditions, whereby the risk-controlling department, on the other hand, deals with the external issues. Risk controlling links the framework conditions and individual prerequisites into risk-adequate control impulses”. According to this, risk controlling is a supporting function, i.e., it analyzes and evaluates the risks, but does not independently take any measures to protect the company from the risk. 30th Risk controlling proceeds in three steps.
Risk optimization is the active influencing of the risks identified and analyzed in the previous steps, taking into account the specific corporate strategy. Basically, there are five instruments available for risk optimization: reduction, avoidance, limitation, transfer, and acceptance. There are some risks that do not need to be taken into account, as some of the risks do not even arise when the contract is drawn up with the customer. The transport risk can e.g. B. can be eliminated by drafting the contract. Another function is the regular review and examination of the efficiency in order to optimize risk.36 Accordingly, weighing up the individual risk control strategies available and finding the right instruments are tasks of risk optimization and risk control.