How Do Firms Manage Financial Risk?

Question 1

In the modern world, it’s common to find companies using derivatives for risk management.
The following are theoretical arguments against the use of derivatives to manage risks. Which
one is not a direct objection to their use?
A. Hedging using derivatives requires specialized skills, knowledge and infrastructure,
besides involving massive data acquisition and processing
B. Aggressive hedging may distract a company’s management from its core business
leading to low productivity
C. Risk managers may prioritize personal interests at the expense of the shareholders
D. Trading in derivatives comes with compliance costs, strict accounting regulations and
compulsory financial disclosures that can reveal key business strategies to competitors

Answer 1

The correct answer is: C)

The use of derivatives for risk management has practical objections. However, the interests of
managers and shareholders do not prominently feature in such a strategy. Furthermore, the
shareholders may put in place the so-called ‘motivators’ to streamline their interests with those
of the managers.

Question 2

Practical Objections of use of derivatives

Answer 2

A. Hedging using derivatives requires specialized skills, knowledge and infrastructure,
besides involving massive data acquisition and processing
B. Aggressive hedging may distract a company’s management from its core business
leading to low productivity
D. Trading in derivatives comes with compliance costs, strict accounting regulations and
compulsory financial disclosures that can reveal key business strategies to competitors