Risk management applies the notion that risks can be mitigated through the practical and historical analysis of an element, respective of the variability of its conditions. This practice is inherent in the individual lives of today’s members of society as well as the business world.
Corporations must assess the risks present in their capital raising investing methodology and must evaluate the potential aspects that may enhance or endanger the continuation of their enterprise.In the Risk Management simulation, the director of the investment consulting company, Kramer Associates, is responsible for allocating investment funds of three clients (Adrian, Tonya, and John) in the markets for stocks, bonds, and Treasury bills. The director must achieve success in managing the investment portfolio of each client, such that the desired rate of return in growth is met and the investments markets align with the risk tolerance profile of the client. Adrian wanted to see high growth in his investments in a short time frame and was not adverse to riskier trades.Tonya wanted to see stable growth over a ten-year period at moderate risk levels. John, who was retired from the workforce, wanted to see steady growth in low risk investments over a 5 to 6 year period at a conservative risk level.
The director of Kramer Associates faced the challenges of achieving the desired rate of return for each client, anticipating market fluctuations, and diversifying investments based on risk profiles. Client dissatisfaction of results or methodology could end in termination of services with Kramer Associates.Such challenges are shared across many businesses. Businesses invest in other markets as a form of raising capital while hedging risks in other projects or investments. General Electric As a leading company, GE operates in multiple industries on a global scale.
They must ensure effective strategies are in place that governs its financial management. GE’s annual report during 2002 and 2004 (10-K/A) showed improvements in liquidity (refer to chart below) (http://www. ge. com/ar2004/index.
jsp). This reflects the company’s ability to meet its current obligations.Another important aspect of the business financial management is the capital structure. Using the pie theory, if the goal of the company’s management is to make the company its most valuable, they should establish the most appropriate debt-equity ratio (stock to debt) that achieves the end goal (Ross et al, 2002). The school of thought on equity/debt pie slicing is 40/60 or 60/40 rule.
Additionally, the leverage structure should support maximizing stockholders interest. Again looking at the annual report for GE, debt leverage greatly exceeds that of the owner’s equity (refer to chart below).In 2002, Bill Gross, manager of the world’s biggest bond fund, Pacific Investment Management, criticized GE, “saying the company is carrying too much debt” (http://www. the-catbird-seat. net/GE. htm). This stemmed from GE Capital’s move to sell $50 billion in bonds days after investors purchased $11 billion of new bonds (http://www.
the-catbird-seat. net/GE. htm). Gross also advised that GE Capital “[had] commercial paper outstanding adding up to three times the size of the company’s lines of credit with its banks”, which could increase risk for investors (http://www.the-catbird-seat. net/GE. htm).As it is the combination of debt and equity that establishes the value of the company, management of debt is key in ensuring available means of financing and a reduction of GE’s debt seems optimal for building investors interests in the long-term.
In the area of risk management, GE is mindful of the need to manage risks and utilizes the strategies of cash flow hedges, fair value hedges, and net investment hedges.With cash flow hedges, when the company makes a fixed rate loan, GE enters into contract with a counter party where GE pays the counter party a fixed rate but the counter party pays GE variable rate of interest (referred to as an interest swap) (http://www. ge. com/ar2004/index. jsp). In the case of fair value hedge, GE uses “interest rate swaps, currency swaps and interest rate and currency forwards to hedge the effects of interest rate and currency exchange rate changes on local and nonfunctional currency denominated fixed-rate borrowings” (http://www.
ge. com/ar2004/index).Despite concerns surrounding the company’s leverage, GE continues to report net earnings: $15. 2 billion in 2003 and $16.
8 billion in 2004. Conclusion Financial management plays an important role in the success of not only small businesses such as the ones in the simulation, but also large conglomerates such as General Electric. With a company like GE that holds so many interests in so many different markets in the United States, as well as globally, efficient financial management is crucial. Working capital is what floats a business.
Without enough cash to pay suppliers, the suppliers will stop supplying necessary products.Mergers and acquisitions are also a financial management tool and can be used to pay off debt and create a larger operating income. Managing finances comes with a certain amount of risk, if all money were placed in checking or savings accounts; the chances of growth are slim.
Efficiently managing and understanding the related risk is extremely important. Upper management of General Electric have been successful at managing all financial aspects in their businesses and that is what makes them one of the most powerful Fortune 500 companies today.