Financial Risk Assessment Checklist

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1. Modeling.

• Overview. Assessment of financial risks starts with creating risk models that describe various domains of finance.  There are three kinds of risk models focusing on market, credit and operations. The models are described below.
• Market Risk Model. This model investigates the change in value of assets due to changes in underlying economic factors (interest rates, foreign exchange rates, macroeconomic variables, foreign exchange rates). The role of this model is to forecast any changes of the economic environment your business organization operates in. You can use the variance approach or the historical simulation technique for measuring market risks. Your model will address the following kinds of market risks:
  • Equity risk
  • Interest rate risk
  • Currency risk
  • Commodity risk
• Credit Risk Model. This model highlights the change in value of debts due to changes in the ability of counterparties to meet their contractual liabilities. The credit model helps determine the credit rating that describes the ability of your organization to perform its contractual obligations. Qualitative analysis will help you create the model and determine credit scoring. The following tools are required for conducting the analysis:
  • Financial performance data of your organization
  • Macroeconomic forecasts
  • Cash flow statement
• Operational Risk Model. This model describes the risk of loss resulting from inadequate or failed use of internal processes and resources. Any mistakes made in fulfilling financial transactions and operations will be the input data for this kind of risk models. You can use "till date insurance" as the only way to model and predict operational risks.

2. Hedging.

• Overview. When you have the risk models you can plan for hedging financial risks affecting your company. Hedging is a process of transforming unacceptable risks into an acceptable form. The process includes a range of steps which are describes below.
• Evaluate the Cost of Hedging. First of all you must admit that your hedging strategy requires some money. To accurately evaluate the cost of hedging, you can try to consider it in light of the implicit cost of not hedging. The hedging cost will be the cost of insuring implicit risks (such as interest rates or exchange rates).
• Use Hedging Tools. There are two effective tools to hedge financial risks – Forwards and Options. Each of the tools comprises of several building components that help ensure financial stability of your company. These components are:
  • Forwards: Swaps, Futures, FRAs, Locks.
  • Options: Caps, Floors, Puts, Calls.
• Control the Process. You need to have a system of controls to ensure that the hedging process is ...

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