Risk analysis is frequently employed by foreign exchange analysts to evaluate the risks underlying foreign exchange transactions. Explain the objectives of risk analysis and the main techniques used in risk analysisIntroductionForeign exchange risks form one of the most common risks that many firms encounter and, in recent times, the management of this particular risk has come to be one of the most significant (key) factors in the overall financial management of firms. As a consequence, risk analysis is often employed by foreign exchange analysts to evaluate the risks underlying foreign exchange transactions.
Risk analysis can basically be defined as a technique used in identifying as well as assessing various factors that may put at risk the attainment of a firm’s goal. Risk analysis also encompasses a preventive measure that helps reduce the likelihood of these factors occurring and identifying countermeasures so as to successfully contend with these limitations when they arise, as a result preventing the likely negative outcomes on a firm’s competitiveness. This particular paper therefore intends to clarify the objectives of risk analysis and the main techniques used in risk analysis. Effective risk analysis is increasingly significant to the success of any organization.
As highlighted by the Global Risk Assessments Inc. (2004), risk can be a driver of significant strategic decisions; it can be a reason for uncertainty within the organization or it can basically be embedded in the organization’s activities. As a result, effective risk analysis is increasingly significant to the success of any organization. One of the major objectives of risk analysis is that it offers a mechanism that helps identify which risks signify opportunities and which ones signify potential pitfalls.
Subsequently, an organization’s wide approach towards managing the risk enables the organization to take into account the possible impacts of the risks on all activities, products, processes, and services. Therefore, according to the PricewaterhouseCoopers (2010), when done correctly, risk analysis, provides the organization with a clear understanding of the various variables that they may be exposed to, whether forward-looking, retrospective, external or internal. A good risk analysis is anchored in a firm’s well-defined risk enthusiasm and tolerance, and offers the basis for determining risk responses.
A robust risk analysis process when employed continually throughout the firm empowers a firm’s management to better identify, assess, as well as take advantage of the right risks for the firm’s business, while at the same time maintaining the proper controls in order to ensure efficient operations and regulatory compliance. Another reason why risk analysis is frequently employed by foreign exchange analysts to evaluate the risks underlying foreign exchange transactions is that carrying out risk analysis enables firms to hedge (or mitigate) the enumerated downside risks and fluctuation of the organization’s foreign exchange exposure by using the derivatives market.
As highlighted by Popov & Stutzmann (2003), economies are becoming more and more open with global trading continually increasing, as a result firms are getting more exposed to foreign exchange rate fluctuations. Foreign exchange risk analysis is thus crucial for firms that are frequently trading within the global market.