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The role of financial derivatives as a risk management tool

1. Discuss the role of financial derivatives as a risk management tool. Based on the company American Express give specific examples of effective and/or ineffective uses of derivatives in financial risk management.

2. Discuss specific examples of best and worst practices by financial services firms relative to Enterprise Risk Management.

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1. Discuss the role of financial derivatives as a risk management tool.

When companies use financial derivatives as a tool for risk management, they do so in the form of a hedge. One of the main problems and risks associated with multinational companies is that they are subject to foreign exchange rate fluctuations. Foreign currency rates vary almost every day and are never completely stable for an extended period. This can work in favor of the multinational company or against the company. If a foreign currency begins to rapidly depreciate where the company is doing business, the foreign exchange values will drop far below the U.S. currency and the company will lose money on foreign transactions. One of the ways to protect against foreign exchange currency fluctuations is for companies to engage in hedging, and one of the forms of doing so is by using financial derivatives. A derivative isn't a security, it's essentially a contract with an underlying security. The derivative itself is an agreement that fixes the exchange rates on which the prices and terms will be based, and also fixes the dates of payment so that the parties don't lose money by engaging in international transactions. By using derivatives as a risk management tool, it encourages businesses and individuals to engage in global investing. If derivatives were not able to be used to fix the conditions of the underlying asset, both individuals and businesses would be hesitant to lose money on business deals, stocks, bonds, ...

Solution Summary

1. Discuss the role of financial derivatives as a risk management tool. Based on the company American Express give specific examples of effective and/or ineffective uses of derivatives in financial risk management.

2. Discuss specific examples of best and worst practices by financial services firms relative to Enterprise Risk Management.

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