Risk Management
Scope of treasury risk
Treasury risk management identifies, measures, and mitigates financial exposures so that unexpected market moves do not threaten liquidity or earnings. The main categories are market risk (interest rate, FX, commodity), credit and counterparty risk, liquidity risk, and operational risk including fraud.
Concepts
- Exposure measurement: gross versus net exposure, natural offsets, and forecasted versus committed exposures.
- Hedging tools: forwards (OTC, customizable, carry credit exposure), futures (exchange-traded, standardized, margined), options (premium paid for upside protection), and swaps (exchange cash flows).
- Hedge policy: documented objectives, hedge ratios, permitted instruments, and a prohibition on speculation.
- VaR and sensitivity: VaR estimates loss at a confidence level over a horizon; stress tests capture tail events.
- Counterparty risk: ISDA agreements, collateral, and credit limits.
- Operational controls: segregation of duties, confirmations, payment authorization, and fraud detection.
Traps
Confusing hedging with speculation; assuming forwards and futures have identical credit profiles; forgetting basis risk; ignoring the upfront cost of options; treating VaR as a maximum possible loss.
Worked example
A U.S. firm will pay €1,000,000 in 90 days. It buys a forward at 1.10 USD/EUR, locking the dollar cost at $1,100,000. If spot at settlement is 1.15, the forward saves $50,000; if spot is 1.05, the forward costs $50,000 more than spot. The hedge removes uncertainty, not the possibility of an unfavorable outcome.