Karen A. Horcher - Essentials of Financial Risk Management

Contents

Essentials Series

The Essentials Series was created for busy business advisory and corporate professionals. The books in this series were designed so that these busy professionals can quickly acquire knowledge and skills in core business areas.

Each book provides need-to-have fundamentals for those professionals who must:

• Get up to speed quickly, because they have been promoted to a new position or have broadened their responsibility scope
• Manage a new functional area
• Brush up on new developments in their area of responsibility
• Add more value to their company or clients

Other books in this series include:

Essentials of Accounts Payable, Mary S. Schaeffer

Essentials of Balanced Scorecard, Mohan Nair

Essentials of Capacity Management, Reginald Tomas Yu-Lee

Essentials of Capital Budgeting, James Sagner

Essentials of Cash Flow, H. A. Schaeffer, Jr.

Essentials of Corporate Performance Measurement, George T. Friedlob, Lydia L. F. Schleifer, and Franklin J. Plewa, Jr.

Essentials of Cost Management, Joe and Catherine Stenzel

Essentials of Credit, Collections, and Accounts Receivable, Mary S. Schaeffer

Essentials of CRM: A Guide to Customer Relationship Management, Bryan Bergeron

Essentials of Financial Analysis, George T. Friedlob and Lydia L. F. Schleifer

Essentials of Financial Risk Management, Karen A. Horcher

Essentials of Intellectual Property, Paul J. Lerner and Alexander I. Poltorak

Essentials of Knowledge Management, Bryan Bergeron

Essentials of Patents, Andy Gibbs and Bob DeMatteis

Essentials of Payroll Management and Accounting, Steven M. Bragg

Essentials of Shared Services, Bryan Bergeron

Essentials of Supply Chain Management, Michael Hugos

Essentials of Trademarks and Unfair Competition, Dana Shilling

Essentials of Treasury, Karen A. Horcher

Essentials of Managing Corporate Cash, Michele Allman-Ward and James Sagner

Essentials of XBRL, Bryan Bergeron

For more information on any of these titles, please visit www.wiley.com .

Copyright 2005 by Karen A. Horcher. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.

Published simultaneously in Canada.

No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, 978-750-8400, fax 978-646-8600, or on the web at www.copyright.com . Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, 201-748-6011, fax 201-748-6008, or online at http://www.wiley.com/go/permission .

Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages.

Notice to readers:

The material contained is provided for informational purposes. The subject matter is complex and must be tailored to individual situations. Although the materials have been prepared with care, errors or mistakes may have inadvertently occurred. In addition, rates and transactions may be purely fictitious. Hedging may not be appropriate in all circumstances. If expert assistance is required, the services of a competent professional should be sought.

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Library of Congress Cataloging-in-Publication Data:

Horcher, Karen A. Essentials of financial risk management / Karen A. Horcher.

p. cm. (Essentials series) Includes index.

ISBN-13 978-0-471-70616-8 (pbk.)

ISBN-10 0-471-70616-7 (pbk.)

1. Risk management. 2. Financial futures. I. Title. II. Series.

HD61.H58 2005

658.155dc22

2004029115

For Uncle Jimmy

Preface

Financial markets are a fascinating reflection of the people behind them. Usually interesting, occasionally irrational, markets take on a life of their own, moving farther and faster than models predict and sometimes concluding with events that are theoretically unlikely.

There is tremendous value in a qualitative, as well as a quantitative, approach to risk management. Risk management cannot be reduced to a simple checklist or mechanistic process. In risk management, the ability to question and contemplate different outcomes is a distinct advantage.

This book is intended for the business or finance professional to bridge a gap between an overview of financial risk management and the many technical, though excellent, resources that are often beyond the level required by a nonspecialist.

Since the subject of financial risk management is both wide and deep, this volume is necessarily selective. Financial risk is covered from the top down, to foster an understanding of the risks and the methods often used to manage those risks.

The reader will find additional sources of information in the appendix. Of course, no book can serve as an alternative to professionals who can provide up-to-the-minute guidance on the many legal, financial, and technical challenges associated with risk management.

Acknowledgments

My approach to risk is unavoidably influenced by my experience as a trader. I had the good fortune to be in a good place at the right time and to learn from others who willingly shared their experience. I am most grateful to the many people who have offered me a helping hand, encouragement, or inspiration along the way, including my clients.

My appreciation goes to Bernice Miedzinski and Melanie Rupp for their helpful insight and perspectives, and to Stephanie Sharp for her support. Many thanks to Sheck for providing me with the opportunity. Special thanks are due to Paul for his encouragement and strength, and to Ashley.

CHAPTER 1

What Is Financial Risk Management?

After reading this chapter you will be able to

• Describe the financial risk management process
• Identify key factors that affect interest rates, exchange rates, and commodity prices