ASSIGNMENT 2

Assignment 2

Assignment 2

Introduction

Risk management is the process of risk prioritization by risk identification and assessment. Management of risk requires a coordinated and economical management of resource utilization in order to monitor minimize and control the likelihood and impact of unforeseen events. Risks occur from uncertainty in financial markets, likelihood of failure in projects, credit difficulties, legal obstructions, or due to any event having an uncertain root cause. Risks are categorized into market risks, credit risks and liquidity risks etc.

Market Risk

Market risk is described as the risk of position losses due to fluctuations and dynamics in market prices. There are a various categories of market risk:

Equity risk

This is the risk that is related to fluctuations and movements in stock or indices of stock and their respective prices. Fluctuation would also occur in their volatility.

Currency Risk

This involves aspersions that fluctuations would occur in the rates of foreign exchange and their respective volatilities.

Commodity Risk

This is the risk that is involved in the changes and fluctuations of the commodities price. These include crude oil, copper, corn etc.

CapitaLand Market Risk Analysis

Interest rate risk management

One of the kinds of market risk that the company faces is of the risk of interest rate. This involves the company's exposure to market risk in the light of fluctuations in the interest rates. Interest rate risk management is related mostly to the investments of the company in financial products and debt obligations. The purpose of the investment is neither speculative nor trading, instead it is meant to generate short term. The cash at bank accounts do not derive high returns; hence financial products are the most prudent choice for investment. Financial products include fixed deposits or short term commercial bills which derive higher and appropriate returns in relation to the cash in bank accounts (Lakonishok, J, et al, p.837, 2007).

In an attempt to reduce the exposure of interest rate volatility, CapitaLand employs hedging instruments that includes interest rate swaps and caps. This is one of the kinds of hedging. Hedging involves the use of derivatives in order to minimize risk. Offsetting a gain on one item with a loss on another is one of the ways to minimize risk. CapitaLand uses cash flow hedge according to the information that is mentioned in the reports of CapitaLand. The risk that is being hedged is related to the fluctuation in the value of cash flows in future is how a cash flow hedge functions. In this method, there is no gain or loss initially as the occurrence of cash flow is yet to take place. The gain or loss on the hedging instrument comes under the reserves head and is transferred to income statement when the hedged transaction hilts the statement of comprehensive income. However, it has been observed in the financial statements of CapitaLand that the company incurred a fair value loss of interest rate swaps and caps for the year 2012. The fair value loss as at that date amounted to $183 million, in relation to ...