In today’s uncertain business environment it is essential for companies to reduce their exposure to market risk. By understanding the economic conditions, assessing risks, and implementing effective strategies, companies can better manage uncertain financial times and stay ahead of their competition.
Market risk is the threat that the combination of volatile and often unpredictable financial markets and economic conditions present for business performance. Ongoing changes in demand, supply, input prices, interest and exchange rates, and legislation, for example, can negatively impact the value of a company’s products and services.
During the global financial crisis of 2008-2009, many large global investment banks failed to appreciate or manage the risks associated with investments in subprime mortgage-backed securities. As mortgage default rates rose and the value of underlying assets plummeted, most banks moved too late to reduce their investments, suffering losses on a scale that collectively collapsed the global banking system.
In today’s business landscape characterised by volatility and rapid technological change, effective risk management remains a challenge for most companies. Fortunately, there are a number of market risk mitigation strategies that companies can implement to avoid or reduce losses and better manage their investments.
All these approaches begin with understanding the economic conditions and trends that influence markets. Taking the time to read economic reports, understanding policy changes, following financial news, and understanding commodity cycles, currency movements and geopolitical shifts.
All of these help companies manage market risk by anticipating and adjusting for volatility.
Companies should thereafter identify the primary market risks their particular business faces, building a relevant plan to protect themselves and limit losses. This plan should include measures such as diversifying portfolios, hedging against losses, and the regular evaluation of investments. In addition, companies should stay up-to-date with evolving policies and regulations that affect their specific industry. Risk management processes should be regularly reviewed, especially in light of new risks emerging as a result of technological changes.
Before formulating a strategy to manage market risk, however, it is important to identify the types of market risk to which a business may be exposed. These include:
1. Interest rate risk: Borrwing costs increase or decrease in response to changes in interest rate.
2. Foreign exchange rate risk: The exchange rate of a currency changes due to domestic policies or international economic events.
3. Liquidity risk: The inability to raise funds when needed.
4. Commodity price risk: Changes in the price of commodities, such as oil, food, and agricultural products can impact margins, volumes and performance.
5. Credit risk: Customers often default on their payments or other counter-parties may not be able to fulfil their obligations.
6. Equity price risk: The value of stocks and other equity assets often change, altering the valuation and capital holdings of companies.
A number of strategies can be used to manage market risk in volatile business environments, including:
Market analysis. This involves the identification of threats and opportunities that may be missed or overlooked in everyday operations by researching relevant data on the industry through competitor and customer analysis.
Conducting market analyses allows businesses to better understand the marketplace and gain insight into the factors affecting their business.
Diversifying investments. Diversification is a key strategy to manage market risk. It involves investing in a range of different assets, both within and outside of the business. By spreading risk across different markets and economic conditions, businesses can adjust their portfolios to remain profitable in any situation.
Hedging risk. Protects businesses from market fluctuation by setting up a contract which protects against losses by reducing the impact of downside volatility.
Monitoring competition. Keeping an eye on competitors is essential to understanding the marketplace while spotting trends, new products, and strategies to stay ahead of the competition.
Leveraging Technology. Technology has become an indispensable tool for managing market risk in today’s business environment. Predictive analytics and artificial intelligence allow businesses to make better decisions faster.
Technology can also be used to monitor and analyze market data to identify trends and adjust strategies. Deploying automated risk management systems, for example, can help companies measure and monitor risk exposures, quickly identify and fix errors, and anticipate new sources of risk as they provide more detailed and accurate data for decision making.
Coronation has built the ability to help clients maximise their returns on investment by sucessfully managing market risk in volatile environments through adopting all of the strategies enumerated above.