What is the company's philosophy towards financial risks?
Only the board of directors can assess and allocate the risk-bearing capacity of a firm which in turn depends on the risk culture of the firm. The board must state clearly the firmís risk philosophy regarding financial risks. Once this is stated in black and white, the firmís senior management will be able to work out the organisationís risk-bearing capacity and formulate the significant policies relating to the management and control of financial risks. Even a financial-risk-averse firm will often find itself facing financial risks which have resulted from core business deals. It may for example have to take out a floating-interest rate loan to finance a project. Such a loan exposes it to the vagaries of interest rates which may go up and down during the life of the loan. The firm thus faces interest rate risk which it decides to hedge. A risk-averse organisation will permit no mismatch between the hedge and the transaction to be hedged in terms of interest rate reset dates or termination dates; a finer point of detail that can only come from a clear annunciation of the firmís risk culture. But even if there was no mismatch in interest reset and termination dates, there will still be some inherent risk in the hedge because the loan will probably be hedged by a swap. Because the two instruments are similar but not identical there will be basis risk which arises whenever there are imperfectly-matched offsetting risk positions. Therefore even a risk-averse firm must establish a good risk control system, because financial risks are part and parcel of todayís corporate life.