Financial risk management has ranked very high on the corporate agenda since the early 1990s, but the large losses that precipitated the latest economic crisis indicates that firms are still a long way from managing their financial risks effectively.

This Management Accounting Guideline (MAG) summarizes the basic principles of financial risk management. The MAG first briefly outlines (a) the different types of financial risk that firms may face, (b) the basic elements of a risk management framework, and (c) the benefits of managing financial risks. The MAG’s core sections then focus on the interlinked issues of risk assessment (or quantification) and possible control tools.

The basic elements of a financial risk management system as outlined in the Guideline are:

• Risk identification and assessment

• Development of a risk response

• Implementation of a risk control strategy and the associated control mechanisms

• Review of risk exposures (via internal reports) and repetition of the cycle

This framework is outlined as the basis for managing the different types of financial risks that a company may face including risks related to:

·         Interest rates, credit quality and liquidity

·         Commodity prices and foreign exchange rates,

·         Equity prices, and an organization’s access to financing.

Risk assessment and control tools are suggested for each type of financial risk, including:

the use of forward, futures and options contracts as well as internal and external hedging and netting strategies. Real-world examples are used to illustrate the discussion.

A case study of the financial risks and the financial risk management choices available to Pietrolunga, a fictitious specialist Italian lumber merchant, shows how the suggested methods may be applied in practice. A glossary of key terms provides a quick source of reference.