Name Muhammad Mohsin Reg no..

MM121043

How Do Financial Firms Manage Risk?

In this paper we study how firms manage risk by examining association between financial and operational hedging of bank holding companies. Results of this paper show that there is a negative relationship between financial hedging and operational hedging. According to the authors risk is managed by lemmatize cash flow volatility. Not only specific transactional exposures managed by firms but also aggregate volatility are managed. Capital market imperfection is less costly than cash flow volatility. It is not defined clearly that how firm manage this risk. For judge the uncertainty of hedging a lot of firms use derivatives. Todays firm hedge specific transaction but according to the theory firms should not manage only specific transaction but also manage aggregate risk because operational decision also very important with financial derivatives for manage the risk. The main aim of manager to reduce volatility of the cash flow which is done by diversifying cash flow. Diversification is done by project selection and acquisition. So that we create flexibility in investment. We take bank holding companies as a sample for check the impact of operational decisions for managing risk by firms. One thing is clear ultimate goal of risk management is not a value creation. Firms which focus on human capital and have larger financial cost can receive most benefit from risk management and to get maximum benefit from risk management we should create cooperation between financial and operational hedging. Due to this reason bank focus on human capital. In this article author tries to measuring volatility change directly. Potentially costly volatility is reduced by operational decisions. Different level of traceable risk has different financial hedging. It is proving that hedging extends from derivatives use but long term hedging is provided by operational hedging
for exchange rate exposure. Leverage and investment is used to regulate risk in firms. Financial hedging is a substitute of vertical integration. Operational flexibility is offered by mergers. For test the relationship between operational and financial hedging three empirically testable hypotheses are developed. First hypotheses is operational hedging can provided by Acquisitions for this purpose empirical test is conducted. It is concluded that if lemmatize cost volatility then acquisition is an operational hedging. The amount of operational hedging is measured by examine the impact on the acquirers volatility. Integrated risk management is very important concept. Second hypothes Is that not only transactional exposure ,aggregate risk is also managed by Firms.Aggregate risk managnent has a lot of benefits in a harmonized manner. In which we examin how we can

combine operational risk with credit and market. discuss the benefits of addressing in a joint risk distribution. By minimizing the costs of total cash flow volatility hedging also adds value. Optimal risk management does not focus only specific transactional exposures but also manages total volatility. Some already work which is done on this topic is a contradicts the theoretical expiation and some evidence also given on it that these firms manage aggregate risk. Some researchers say reducing volatility has a alternative of reallocation risk. In short according to this hypothesis operational hedging is provided by acquisitions. In this paper author Assess an acquisitions impact by using derivatives. For maintain same level of volatility, a smaller percentage of its exposure must be financially hedged. If only specific transaction exposures are manage then change in aggregate risk are irrelevant. Third and most important hypothec is that financial and operational hedging are substitutes.