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Financial Risk Management

Students First Name, Second Name(s), Surname

Institutional Affiliation.

Course Name and Course Number.

Instructor and Title.

Due Date
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Financial Risk Management

Companies today face financial risks and they accept or mitigate them to avoid future

losses. Financial risk management involves identifying risks, analyzing them, and making

investment decisions based on accepting or mitigating the risks (White, 2020). Financial risks

can be quantitative or qualitative and the financial managers use financial instruments to protect

the business against them. Some of the commonly used approaches for quantifying financial risk

are regression analysis, value-at-risk analysis, and scenario analysis. These analyses help to

determine the risk and the reward of any investment decision.

Risk and reward have a positive correlation. The relationship between the two is positive

and they move in the same direction ("risk-return relationship," 2021). However, taking greater

risks does not guarantee greater rewards. Greater risks may also result in greater losses if the risk

is not well managed. Low risks are associated with lower potential rewards or losses. According

to the risk-reward tradeoff, an investor can only have greater rewards if they accept a higher

possibility of losses. For example, LTD wants to increase its profitability/ returns by allocating

the assets more aggressively. Therefore, taking the risk of investing a high amount of premium

dollars might earn the company higher returns if the risk is well calculated.

The Chief Financial Officer (CFO) believes that LTD company should take calculated

risks and allocate the assets more aggressively. The organization appears to be in a better

position on paper than it is. This could be because of errors or omissions in the financial

statements due to factors other than a failure of internal control. The financial statements of the

company like balance sheet, income statements, and statement of cashflow only provide helpful

partial information but do not report on the value of the business or its ability to take financial

risks. The business books of LTD show that the company is yet to experience a year period with
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high loss ratios. It does not necessarily mean that the company can increase risk exposures. The

firm’s systematic framework for managing risk is important as it will help to identify the sources

and causes of financial risks, analyze the impact of the risk over the company and prepare the

plans to mitigate the risk or avoid the risk. Like in LTD’s case, it shows that the company should

not increase risk exposure at the time.

Financial risks that are not properly managed have negative impacts on the business. The

company suffers huge losses that may even result in business failure. The losses can also lead to

bad reputations and losing customers. Apart from the company suffering from the losses,

financial losses have impacts on policyholders, shareholders, vendors, creditors, and employees.

All the above parties can be adversely impacted if LTD company suffers losses as a result of a

more aggressive approach.

Policyholders

If LTD suffers losses, it will have a negative impact on the policyholders. Policyholders

are the people that are covered under an insurance policy. LTD Acceptance has 18,000 active

policies for sports cars and motorcycles. During a financial crisis, the company will not be able

to cover the claims made by its customers. However, when the company becomes financially

troubled and can’t pay policyholders’ claims, its headquarter company will come to the rescue

(Huddleston, 2020). For example, in this case, LTD Capital will come to the rescue of LTD

Acceptance.

Shareholders

Shareholders will also suffer from losses when LTD Acceptance suffer loss as a result of

investment aggressive approaches. The shareholders are the persons or companies that own at

least one share of LTD stock. They reap the benefits of the company’s success. In case of losses,
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the shareholder all be subject to capital losses and decreased dividends. Another impact on the

shareholder is that the shares will decrease their value. During losses, it means that the

shareholder dividends will decrease or will not enjoy any dividends. Due to losses, the

shareholders will lose their faith in the company thereby selling their shares, and leaving the

company.

Vendors

Business losses have adverse effects on vendors. Vendors are the suppliers of goods and

services to a business. The vendors of LTD Acceptance also suffer will losses. For example, if

the vendors that have sold goods such as machines to LTD Acceptance on credit and the

company cannot pay for the items, the vendor will suffer losses. Also, the vendors will lose a

client since LTD Acceptance will not be able to buy more goods and services from them.

Therefore, LTD losses will have a negative impact on the vendors.

Creditors

Creditors of LTD acceptance will also face losses from losses as a result of aggressive

approaches. Creditors are the individuals or companies that lend funds to another company.

Losses of a company have negative impacts on creditors. For example, when LTD suffers losses

it will not be able to pay the creditors as it did not earn the money to pay them. Also, the

creditors will reduce their outputs as their operational costs will decrease. Hence affecting their

revenues and profits. Therefore, the creditors can adopt tighter credit policies and increase their

interest rates.

Employees

Company losses have negative impacts on the employees. For example, if the LTD

Acceptance suffers huge losses, the company will have to cut down some expenditures. It might
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result in laying off some employees and decreasing the salaries of the remaining employees.

Also, the employees that are responsible for the losses may be suspended or terminated.

Adjusting building materials and operation procedures to reduce operating costs as a way of

recovering from the losses may have a negative impact on the employees.

Effective financial management aligns with overall risk management. Financial

management is related to other risks such as market risks, credit risks, operational risks, liquidity

risks, and legal risks (Nath, 2020). Management of financial risks also helps to manage the

related risks. For example, managing financial risk in the events of devaluation of the currency,

which may result in financial losses aligns with the management of market risks. Also, financial

management aligns with operational risks. Some operations may lead to financial risks and vice

versa. For example, fraud in LTD Acceptance can result in operational and financial risks.

Inherent risks can also lead to other risks in the company such as liquidity risks. Therefore,

effective financial management aligns with the overall risk management of the company.

Conclusion

In conclusion, the assumed risks from LTD Acceptance activities should be consistent

with long-term goals. All the organization’s risks are well calculated, and the finance managers

develop mitigations that will be applied when the risk occurs in the future. Therefore, all the

risks assumed will be consistent and will serve the long-term goal. However, if the managers

engage in activities that create risks outside the scope set, it may create problems for the

company. For example, if the CFO of LTD purely looks at the rewards and not the risks when

allocating the assets aggressively, it may lead to huge losses. The losses may occur since the risk

is not well calculated in the company’s systematic framework for managing risk. Therefore,

financial managers should be consistent with the company’s long-term goals to avoid derails.
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References

Huddleston, C. (2020, September 1). What happens if your insurance company goes out of

business? Forbes Advisor. https://www.forbes.com/advisor/life-insurance/company-out-

of-business/

Nath, S. (2020, July 15). 7 types of financial risks with real-world examples. Beginners

Buck. https://www.beginnersbuck.com/financial-risks/

The risk-return relationship. (2021, June 4).

GetSmarterAboutMoney.ca. https://www.getsmarteraboutmoney.ca/invest/investing-

basics/understanding-risk/the-risk-return-relationship/

White, D. (2020, March 13). Financial risk management: Everything you need to know.

Techfunnel. https://www.techfunnel.com/fintech/financial-risk-management-guide