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RISK MANAGEMENT PRODUCTS USED BY MNCS
1.0 Currency Risk Management Products
1.1 Forward contracts: securing future exchange rates
Forward contracts are to a considerable extent being used by the multinational companies so as to cover
for the risk of exchange variation through agreeing on the today’s price on the foreign
currency. Concerning the currency risk management practices in Nigeria, Adamu, Isah, Liman & Shabu,
(2021) reveal how use of forward contracts assist the firms to achieve calculated exchange rates of the
firms future operations. These contracts ensure that, in terms of cash, the firm will be able to receive or
make certain amount of payment at given time thus protecting the cash receipts and payments from
fluctuations in the exchange rates which is very important, especially for firms who source their raw
materials, funds, or sell their products in the foreign countries with different currency than domestic
currency. Through the use of forward contracts to hedge forex risk, companies involved in international
business can enter into contractual agreement at the current time for delivery of a specific quantity of
different currencies at some agreed time in future at an agreed rate of exchange. This policies confer fixity
of exchange rates provide firms with a basis for planning and forecasting their expenses and incomes
because the cost of their transactions in international markets remain constant regardless of changes in the
market. For example, an exporting Nigerian business organization at some time in the future expects to
receive US dollars but the actual payments may occur at a later date can hedge it by using forward contract
for controlling the exchange rate. This goody avoids the possibilities of any depreciation of the Nigerian
Naira against the US dollar that may also have a rubbing off effect on the profitability of their products in the
foreign market. When labeling forward contracts as necessary in the operational corporate treasury,
Almeida, Cunha, Ferreira, & Restrepo (2023) similarly note this in their breviate of corporate risk
management. This form of contracts assist a party to manage exposure and the form of subsequent
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business dealings in an efficient and accurate manner. This means that exchange rate exposure can
actually be controlled for by letting particular rates be fixed, this is whereby the company can well be able to
free itself from any form of financial risk and can therefore well be able to concentrate fully on its core
business. Hence forward contracts also provide flexibility along with being a hedge tool that provides
certainty on cash flow and also acts as a protective measure against the adverse movement in the
currency. It can bear a substantial degree of flexibility regarding such factors as the volume of the given
currency s that is to be exchanged and the exact date of the operation. This transparency enables the
organizations to develop floor specific hedging requirement that may be used to address any possible risks
that emerge.
1.2 Currency options: hedging against currency fluctuations
Another example of the derivative contracts is the currency options which are optimal for self-adapting to
the changes and, thereby, have significant risk mitigation characteristics. Akram and Rime (2019) also
explore various strategies in risk management in regards to trade credit insurer, indicating that currency
option can aid in the mitigation of currency risks. Another difference which lies with forward contracts
where buyers have the option of purchasing currency for a fixed price at some time in the future, currency
options mean that buyers have a right but not the liability for exercising the option to purchase or sell the
currency at a stipulated price within a given time span. Currency options allow for the purchase or sale to
occur in the foreign exchange market at the current market price, and consequently, the organizations can
benefit from this favorable prices at the same time minimizing their losses. For example, an organizational
accountant, who is expecting to receive some payments, in a distant currency, may hedge this position by
providing his firm a call option in order to protect it against any appreciation risks of such currency. If the
currency strengthens, the company can then buy the currency it needs at the agreed call option strike price,
which the company knows beforehand and which in turn provides the company with the opportunity to get
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the currency rate in its favor. Where the magnitude of the depreciation is insignificant or there is steadiness
in currency the company may allow the option to get out of expiry without exercising it, therefore the
maximum that one can lose is that which is paid for the option. This is so, as affirmed by Augustin,
Subrahmanyam, Tang and Wang (2021) arguing that credit risk uncertainty and credit default swaps are, to
an extent, based on risk management theories that depend on options in case of a credit loss in
unfavorable events. In the case of credit default swaps, that is contractual arrangements through which
investors can hedge or gamble on the risk of defaults on lines of credit or bonds, options are the means to
manage the probability of credit defaults. For example, an organization that has invested in corporate
bonds such as holding can trade put options on the said bonds to hedge in subsequent credit risks such as
default. Where as on one hand, both trade credit insurance and credit default swap provides options to
companies and investors based on certain requirements and within measure environment where by they
are able to minimize risks that are associated with their business.
1.3 Currency swaps: exchanging principal and interest
A currency swap involves a currency exchange between two parties where the first part pays a fixed
amount in its own foreign currency and the second part pays the agreed interest in the traded currency;
effective risk shedding of both the exchanged currency and interest rate risk. In this work, Aretz and
Shackleton (2022) provide the results of comparing hedging operational policies of firms in the materials
sector using the commodity futures that can exhibit potential characteristics of operational risks that are
analogous to currency swaps, which may be employed as business tools. These swaps allow an
organization to obtain a funds in a particular currency and to extend funds in another in an effort to hedge
on currency risks, as well as to pay lower interest charges. A currency swap can denote an agreed
exchange of a stream of future cash flows in different currencies between two counterparts. For example,
a business organisation from America needs to get funds for its operation in Europe; it can complete a
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currency swap exercise with a machine partner in Europe. As for the payment, the US company is to pay
the euros because in a swap transaction the parties exchange the borrowed currency while the European
company will pay the US dollar because the currency which the US company borrowed was in such
currency. This has enabled both the companies to obtain funding in their related currencies to their
business withoutyielding indirectly to matters of rates in currencies. They do not include risks associated
with movements in the currency rates that are associated with their operations and this in turn allows them
to better satisfy the relationship between their cash flows and operational needs. Another systematic
literature review by Azad and Shaeri (2022) addresses the risk management The following section looks at
how a company with operation in more than one FL can engage in currency swaps in order to ensure that
the cash flows from the various operations are aligned, thereby removing as much risk exposure to FL
uncertainties as possible. Another common use of foreign exchange instruments that are mostly entered
into by MNCs is through the use of currency swaps, especially due to the fact that such firms operate in
many countries. They can use it to transpart the income which is generated by various subsidiaries in
foreign locations into their home location currency which in turn helps in sharing the impact of currency
translation over different periods. Currency swaps offer a good chance for using not just one type of
currency and for combating with currency and interest rates risks at the same time. They help firms to fund
and invest in different currency and manage or minimize its exposures to risk associated with fluctuating
currency rates and to ensure the available cash balances meets the necessary requirement of the
firm. This fact has been explained by Aretz and Shackleton (2022) and Azad and Shaeri (2022) and that
currency swaps are some of the most imperative tools in risk management for MNCs and especially for the
managerial risks as they seek to expand into the various global markets.
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1.4 Cross-currency swaps: managing multi-currency exposures
Crs is a special category of financial derivatives that is quite useful to hedge various types of currency risks
apart from using it to raise cheap funds. Acharya and Steffen (2020) provide insights into the CD operation
amid COVID-19, as well as describe how CCXY may help companies manage their liquidity-buildup and
funding risks during the economic contraction. These are contracts that stand for cash flow in various
currencies where one cash flow is generally swapped for the other at a given exchange rate to help reduce
variability of cash flows as well as have the purpose of reducing on risk which has tendency of being linked
to foreign exchange. These shortcomings prevail especially when there is low economic performance, for
instance, during the COVD-19 pandemic, where businesses tighten up liquidity and fluctuations in the
exchange rate of foreign currency are manifested. Therefore the cross-currency swaps afford a means of
^financing in other currency while using the earlier undertaken exposure to the respective currency. For
instance, a firm may be using euro as its operating currency while it is established in the United States it
may borrow in euro may therefore use cross currency swap to eliminate the above debt instrument for
instance and manage its forex risk while at the same time ensure that it is aligned to a stable cash
basis. Augustin et al. (2021) define credit risk risk and the credit default swap market -as for pointing how
is used cross-currency swaps in order to eliminate credit risk volatilities which impact the corporate balance
sheets. Nevertheless, it is not only usefulness to evaluate and manage the risk of the currency as cross-
currency swaps can be used to control the credit risk exposures. For instance, an MNC may decide to start
a CCP that contains contingent payment clauses and this will extend to credit risk meaning that fluctuations
in credit ratings wreak cash flow hence will serve as a tool of mitigating credit risk financial
prospects. Cross-currency swaps are also widely used among the commercial banks and other market
counterparties including the sovereigns with the purpose of managing the risks related with foreign
exchange and interest risks effectively. These swaps allow the counterparts to exchange the amount of
principal and the coupon stream in foreign currency effectively reduce the cost of funding in the
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international markets. To compliment this paper, the use of cross currency swaps facilitates in
management of multicurrency risks and reduced funding costs among the corporate and financial
entities. As noted by Acharya and Steffen in 2020 and more recently by Augustin et al. in 2021, these are
flexible solutions that could assist the firms in managing some of the severe threats that accompany the
extraordinary levels of the market risks, including liquidity, currency, and credit risks in the unstable world
economy.
2.0 Interest Rate Risk Management Products
2.1 Interest rate swaps: exchanging fixed/floating rates
These are widely used contracts that provide fixed-for-floating interest-rate return/floatation variants that
corporate entities and dealers in the financial market often use to manage payment/ fluctuation risk. Brez
S. Opric, H. Peltonen, and R. Sarlin, 2023, give sign of distress in European banks and stress how interest
rate swap help banks to manage chain funding risk and interest rate risk. It facilitates institutions to
establish a hedge in expectation of adverse changes on interest rates, bring about matching, and contribute
towards promotion of stability. Interest rate products operate on profit coups that are associated with
various interest rate benchmarks; including the LIBOR or the EURIBOR. For example, a corporate
customer has a variable interest loan and they would like to have fixed interest they go for an interest rate
swap where he or she will pay fixed rate and will receive variable rate. This will assist in protecting the
corporation from gaining really high interest rates and will also assists in creating stability in the
corporation’s cash flows and assistance in evaluating the corporation financially for the future. Similarly, in
the article that explores commodity risk premia, Berrada, Hugonnier, and Rindisbacher (2021) explain that
interest rate swaps can be utilized in shipping business to hedge possible changes, produce financially
conservative, but cyclical shipping businesses. Interest rate swaps provide an effective mechanism for
dealing with financial risks in business activities, which may have high revenues fluctuations and have high
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chances of suffering from fluctuating commodity prices such as the shipping industry, the costs of debt
service associated to revenues may be managed through interest rate swaps. By this, the shipping
operating companies might be in a position to replace variable interest rate by fixed interest rate within their
existing debt structure to reduce the sensitivity to the changing interest rates. Interest rate swaps are also
important to other FI’s and particularly bank which may be trading or attempting to manage some of the
balance sheet exposures of interest rate risks and cost of fund. Interest rate swaps are therefore useful to
banks where the so-called certainty effect is useful, as Betz et al. (2023) explained during turmoil lows
and/or during periods of crisis and/or when cost of funds is high. This is crucial as far as cost avoidance
and management are concerned as well as to ensure that the banks are capable of addressing the
demands of the consumer and the overall economy in the process.
2.2 Interest rate options: hedging rate movements
Interest rate options are very useful tools which are the instruments that leae some space for the
manoeuvre while working with interest rates; especially for investors and other institutions, they provide
insurance against the fluctations of rates. For substantially losing the Consumption CAPM in cross-section,
Bali, Goyal, & Huang (2021) consider that Consumption CAPM fails due to commodity risk and interest rate
options to achieve the hedged consumption risk from stocks and bonds. These are options which are
European types of options, in addition to the call option which is the right but no obligation to buy interest
rate futures at a particular price on a particular date, while put option is the right but no obligation of the
holders to sell interest rate futures at a particular price on a particular date and quite useful to help guard
against unfavourable change in the rates. Interest rate options are particularly applicable when there is
credit risk as like COVID 19 pandemic which according to Boyson et al (2021) is valid by arguing that
during the uncertainty period. opportunities help in minimising the financial risks during the cyclic
economies and assists in implementation of labour relations strategies by providing ways of controlling the
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risks including the variance in interest rates as per the requirements of the financial institutions and
companies. For instance, in the monetary policy, it is useful to use options on interest rates so that the
balance sheets of the financial institutions can be protected from negative shocks with a view of enabling
them to carry on extending credits to the business entities as well as households. The choice of interest
rates have been found to play important roles as identified by Dark et. al in the asset liability management
(ALM) of most financial institutions. Based on interest rate options like the interest rate cap, the interest rate
floor, and interest rate swap, the banks can run a hedge of where they balance between fluctuating interest
rates affecting the valuation of specified assets and the valuation of specified liabilities. Hence, benefiting
from the gains of balance sheet hedging Even though this hedging technique helps to maintain steadines in
its net interest income as well as the financial outcomes, Jain and Sogi (2021) note that. This is because
just like interest rate options allow investors to have flexible operation with regard to assets, so also does it
provide flexibility in the manner in which investors may conduct their operations with regard to
securities. From the perspective of current practice, Kryzanowski and Zhang (2020) has demonstrated how
a financial incumbent can use Interest rate option to address the IR risk more effectively. It is worked out to
assist investors to maximize their profits from the existing investment portfolios when facing the eve-
changing market situation through hedging against the rates’ increase or getting more favorable rates in
case they reduce. For instance, pension funds may seek to hedge some position using interest rate
options in order to offset for the impacts of alterations in the afore-said rates on the value of bonds held by
them.
2.3 Interest rate futures: speculating on rates
Interest rate futures on the other hand refers to the interest rate futures through which the investor could
invest on possible future interest rates and technically hence undertake an interest rate risk hedge. To wit,
in Buckley (2023) concludes with the analysis of pricing of commodity risk in the international stock markets
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and explain and illustrate how in a contrived position, futures on interest rates act as necessary hedge
against the risk pertaining to changes in the price of commodities and aid in the establishment and
enhancement of investment solutions within risky equity products. Interest rate futures contracts are
Financial or Monetary commitments to buy or sell at some future date at a particular price a specified
quantity of a financial instrument. These are on exchanges; this indicates that they can be easily purchased
and sold and an aspect that increases chances of liquidity. Interest rate futures have various users, namely
the expectation users and the hedging users. For the speculators, they hope to realize their gains through
the differential in the interest rate whilst the hedge processors will use the futures as a protective weapon to
have a buffer on any unfavourable change in the interest rates within their portfolios. For instance in global
equity markets; interest rate futures enable the handling of risk exposure due to changes in price of various
commodities that may affect the return on equities. The borrowers can also avoid or reduce the risks on the
potential revenues. .. which through the use of futures contracts in interest rate swaps undertaking the
assurance that the interest rate will remain stable in the future. Chang and Nieh (2022) illustrate an
instance where futures in agricultural commodities may be used asymmetrically, and also shows how
futures in interest rates can be used to enhance agricultural market yield and hedge downside risk. While
price risk, specifically in the agriculture sector is hard to mitigate due to events such as climatic
disappointment and other odds, interest rate futures in a way assists the farmers for instance any producer
of a certain commodity to hedge on price volatilities. For example the farmer can use interest rate futures to
hedge and obtain a reasonable rate from the financier from the market and protect him/her from the ever
fluctuating interest rates that affect profits. Of equal relevance is the same in relation to the interest rate
futures not only the speculative and hedge tool but also as a strategic investment.
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2.4 Interest rate caps/floors: limiting rate exposure
The interest rate cap and floor is one method of controlling on interest rates where in the case volatile
movement of the rates it minimizes the amount that could have been lost as well being a way of getting
accustomed on the management of the itrates. As established by Benos, Niangoran, Pericoli, and
Stackman (2022) the current study revealed the role of credit risk management in trade credit polices
among MNCs especially depending on the use of interest rate caps/floors to minimize the credit risk and at
the same time get the assurance of positive cash flows. Interest rate cap specifies the highest amount of
interest rate that the borrower may be persuaded to pay back, while floors refer to the highest interest rate
that the lender may settle for. Chen and Xiao (2020) use Common Risk Factors to research Global
Currency Hedging, hence, understanding how interest rate caps/floors operate, and how they can be used
to hedge currency exposure and manage Interest Rate Differentials two different countries. It is relevant to
note that these instruments can be very handy for portfolio implementation of interest rate risk
management, allowing achieving a stabilized revenue with potential leveraging factors to boost other
financial frameworks. Where floor and cap options are effective is where there are probable changes that
are expected to happen to the interest rate and this will help in protecting against such fluctuations. They
provide guarantee for borrowers and lenders through capping the upper and lower boundaries on the
potential rates that can be applied, or in other words, the interest rates. These instruments to the
multinational firm to forecast and assess trade credit risk where cash flow risks are linked to rate of interest
fluctuation. Likewise, Interest rate ceiling also poses risks management in that; it protects firms from high
interest costs while Interest rate floors also avoid exposing investor to low interest rate costs as they are
assured a minimum return on their capital investment. Moreover, Chen and Xiao (2020) found out that
interest rate caps and floors perform as active processors of hedge currencies in the international
market. In the era of globalization and international transactions where organizations have to undertake
operations in various countries and environments influenced by specific and distinctive exchange rates and,
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often uneven, interest rates, these instruments are useful in managing for such a risk. A company can
employ interest rate cap when financing activities in a foreign market where the borrowing rates are
fluctuating by providing automatic and finite kind of guarantee of financing costs. Interest rate calculations
linked with the caps and floors supplements financial planning because it gives the client a guaranteed
opportunity in the planning of interest rate fluctuation.
3.0 Credit Risk Management Products
3.1 Credit default swaps: insuring against defaults
Credit default swaps (CDS) is used as an opportunity which can help investors to utilize instruments they
can use for insuring the credit risk through transferring it over the third party. In their study, Duygun,
Shaban, and Sickles (2021) discuss the negative repercussions of underestimating credit risk and prove
that with the help of the CDS, it is possible to avoid greater losses due to mistaken evaluations of credit
risk. They are of the credit default kind, which work akin to insurance warranties; the recipient of the
warranty pays the seller constant cash over the indemnity in exchange for the security. CDS entails that
the owner of the CDS will make payments to the purchaser of the CDS in occurrence of an occurrence of
credit event of the issuer of the debt, which the CDS is based on, event that the issuer gets into a default
position or bankruptcy. Credit default swaps are the significant contracts on the worldwide financial
markets that perform their function as the tools which manage the financial risk and as the objects for
functioning the speculative capacities. They offer flexibility because they afford investors who are in the
position of holding an instrument, tools for reducing their risk without necessarily disposing the
instrument. This ability may be important, for example, especially in the case of institutional investors such
as banks and other asset managers, who are already inherently usually involved in many and perhaps
significant positions of the debt securities. In this essay, we mentioned above how CDS can be employed
in practice and hence give a brief review and conclusion. Also, CDS price is dependent on factors such as
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credit rating of the reference of the bond in question, tenor or term of swap and overall market sentiment
with regards to credit risk. Using credit quality ratings and credit quality spread and other market actors, a
bank uses CDS to evaluate the chances of default as well as the cost of acquiring or giving
protection. These instruments have also provided a view on how much market participants are willing to
pay for protection against credit risk, because the price of Credit Default Swaps is oftentimes analyzed as
an indicator of the market’s expectations of a given debtor’s performance. Some of the financial
organization losses occurred throughout the late 2008/early 2009 financial crisis included exposures to
Counterparties via CDS contracts implying that certain Counterparties had reached critical levels that
demanded increased regulation and transparency.
3.2 Collateralized debt obligations: securitizing credit risk
CDO stands for Collateralized Debt obligation; it is the method which is used to segregate debt obligations
into various series or classes according to the rating given to them concerning credit risk. First,
organizational complexity and corporate risk management are examined by Eckles et al. (2021) and prior to
that, the authors discussed how CDOs should be aligned to contribute to the mitigation of the credit risk,
including in different types of assets. This was the case during the global financial crisis in the year 2008
and the financial tools have advanced to adopt the different methods of risk management. El Ghoul,
Guedhami, and Kim (2022) study the impact of country risk and risk management policies for MNC and in
this study, authors conclude that CDOs can play a positive role to manage credit risk and can enhance the
financial position of the countries in all cases. Collateralized debt obligations or CDO is another type of
ABS financing structure, but for want of a better description it can be defined as BETTER structure formed
by credit risk mezzanine debt products pooled and sliced. Those instruments are meant to securitize credit
risk depending on the calculated flows based on principal and interest obligation from the original
underlying credits. The formation of CDOs allows for the creation of additional tranches with high credit
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rating, which traditionally is associated with a lower level of risk, at the same time creating tranches with
low credit rating that are considered more risky and are expected to yield higher revenues (Eckles et al.
2021). First, CDOs rose to popularity before the occurrence of the 2008 financial crisis situation when its
construction and unclear parts were also the main reasons of massive fails throughout investors and other
financial institutions. They have evolved over the years in terms of structuring/management specifically in
elements such as risk management to avoid/lose money. Some of these enhancements include; improved
risk assessment models for the underlying assets to approximate CDO tranches, improved definitions on
CDO tranches, and improved selection criteria for risky underlying assets (El Ghoul et al. , 2022). Hence,
the decision to popularize CDOs does not lie in an imperative to respond to such risks that emerged from
the financial crisis only, but in the shift towards other goals such as financial stability and markets
diversification. Literature; according to El Ghoul et al. (2022), it is expected to understand that MNCs
utilize CDOs in number of states and sectors for control and financial stability of credits, therefore the
financial position looks more secure. The impact can be managed through risk management on risky
resources that may be exposed to fluctuations in the business environment of certain regions through
implementing a structured investment grade via corporate instruments.
3.3 Credit derivatives: transferring credit risk exposure
Credit derivatives on the other hand can be defined as a broad category of the financial instruments that
make it possible for parties to use credit risk as well as the corresponding exposure. To elaborate, they
argue that Credit Derivatives may be applied for cross-asset risk premiums hedging in monetary policy and
commodities – Fu et al. , 2022. The products include credit default swaps, collateralized debt obligations
investment and other kinds of structure financial products that hold, manage as well as transfer credit risk
and thus enhance the relative financial market liquidity. These are categorized broadly and the most
popular kind is the credit default swaps (CDS) that are actually insurance policies where the buyer pays the
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seller, periodic premiums that can be used to cover losses occasioned by credit defaults. CDSs help
facilitate credit risk mitigation; credit risk management allows a company to handle default risks to its clients
(Sundaram & Das, 2022). Credit derivatives are also known as credit risk transfer products and one of
them is collateralized debt obligation (CDOs) which make packages collections of debt into portfolio of
certain credit risk classes. It became problematic during the 2008 financial crisis, but after the upheaval,
the authorities improved how they dealt with the risks associated with such products and the level of
information disclosed on them to the public (Fu, Huang, & Rindisbacher, 2022). In this regard, the
available evidence of the management of interest rate risk in the UK banking sector is reviewing below;
Diamantopoulos and Ziotis, (2021) employing the credibly mentioned credit derivatives in the banking
systems explained that how the exposure to risk could be managed through the combination of interest
hedging and credit derivate tools. Therefore various financial products including interest rate swap enable
the Institutions of Financial to mitigate and hedge various risks involved in the interest rate as well as the
credit; In the process matching their respective liabilities as well as assets in an effort to improve their
financial position. Thus, instead of the hedge through risk management, credit derivatives are used at the
strengthening of the flows, reinforcing the liquidity in the finance market. They also allow for trading of
credit risk, and these instruments also allow investors to adjust their position in the credit markets on the fly.
They are also employed in speculation to help an investor gain exposure to credit events without holding a
claim through the physical security (Diamantopoulos & Ziotis, 2021).
3.4 Credit insurance: protecting against non-payment risks
Credit insurance aims at operating as an indemnity against risks arising from failure to recognize amounts
on account receivables or credit hazards. Chronicling on from the previous work of G20 currencies index,
Dew, Javed and Xiao is insightful at expressing the variability of currency risk and how currency risk has
detrimental effects on MNEs by the asymmetrical risk-reward paradigm, however an interesting relation is
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how it outlines how credit insurance plays the role of a hedge and enabler of cross-border
transactions. This insurance mostly proves pertinent to credit risks from customers’ bankruptcy, long time
or due to politically induced risk hence it serves as safety net for companies against such
events. Structurally, credit insurance works as an indemnifying instrument that ensures that the firm
transfers the risks account to the underwriter, which is usually a third party. Coverage can be exhaustive in
accordance with the needs as it hedges domestic and international business risks, contributing to the
globalization process by enabling businesses to operate in the foreign countries and, at the same time,
being insured from the credit risks. However, credit insurance is most important during the time when this
particular country or a certain political area is likely to experience some changes that will put people under
pressure of being unable to pay the amount of the loan as initially agreed. At such points, the insurance
provision enables an organization to reduce the amount of actual cash used to cater for claims, something
that helps to sustain an organization while conducting its operations without interruptions due to inadequate
cash (Dew, Javed, & Xiao, 2022). Also, credit insurance has its uses in supporting credit since it gives the
firm another way of getting credit related information and credit related information evaluating
devices. Banks and financial institutions have established stringent qualities through which they determine
the credit worthiness of a client or a potential client as was the case; which can be used by firms in credit
policies to determine the acceptable credit terms and limits. With regard to credit risks, this approach is
effective in minimising non- repayments since credit risks are controlled a priori The argument in the
sustainable growth with the help of the credit control function is also important because it makes for
responsible extension of credit (Dew, Javed, and Xiao, 2022). Credit insurance contributes towards
handling this in one way, by reducing the level of credit risk or credit contamination within financial
facilities. Since through hedging they ensure that a large part of credit risk is controlled, firms help to
prevent occurrence of default chain reactions which are detrimental to the system. This is especially
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relevant in industries where trade credit plays a significant role; one such area is manufacturing and retail,
for instance, supplier’s bankruptcy impacts other players in the credit network (Dew, Javed, & Xiao, 2022).
4.0 Commodity Risk Management Products
4.1 Commodity futures: hedging against price fluctuations
Commodity futures are contracts spanning financial agreements that allow an investor to hedge against
future fluctuations in the price of tangible assets of specific commodities. All in all, in the interest rate risk,
and the management practices among the community banks in the US, Gelman & Tan pointed out that the
commodity futures can be used efficiently in managing interest rate risks and in the achievement of the
strategic planning for financial needs. These futures contracts assist the players in the market to hedge
such things like oil metals and the agricultural products that came early into the market, decreasing the
risks and increasing the cash flows stability. For instance, to avoid a decline in the price that reaches the
agricultural producers’ revenues and cash operating profits more than it would have gone for a speculative
physically-settled futures contract, the producers can use the futures contracts. Hedging enables the
farmer to know when it is appropriate to plant or harvest certain crops if he or she has sold them at those
certain prices. Similarly, other derivatives like commodity futures are being utilized in the energy business
as effective price risk management tools for oil and natural gas. Futures contract is also useful in
managing some risks by providing a known price for a particular good in the future, for example, oil
producers can enter into futures contracts to plan on how to protect them from receiving lower prices of oil
and hence they will be able to cover for the cost of production and also make profits during down times
(Gelman & Tan, 2023). consequently in the metals sector for instance the growth of the commodity futures
are very essential as a hedging tool that assists in dealing with risk influenced materials such as copper,
aluminum and gold. It is possible to assert that the general examples of the methods which can be used by
mining companies and manufacturers in an attempt to manage risks can be Submitted with futures, it
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stabilize the future prices and, therefore, ensure profitability in future, thus, managing the margins (Gelman
& Tan, 2023). Nonetheless, the hedging usage is gradually becoming more common in the shipping
industry generally through the use of commodity futures to manage fluctuating the freight rate
risk. According to Kavussanos and Tsouknidis (2023) the reduction of the operational risks associated with
change in shipping price can be addressed by employing space freight derivatives which falls under the
category of the Commodity Futures.
4.2 Commodity options: securing future commodity prices
Commodity options are instruments that give the right to an investor to make a call or a put concerning a
certain commodity but without requiring that the individual has to buy or sell the particular commodity at a
set price during a specified period. When it comes to commodity options as explained by Giamouridis and
Skiadopoulos (2021), there are several ways through which they act as a hedge against the term structure
of interest rates and commodity price risks that are anticipating future movements of interest rates and
prices of commodities in the market. These options offer; ability to manage price risk; risks in future of
prices may be secured in order to control market movements. Commodity options’ usefulness as risk
management products in the business/production companies and the directions in the current unpredictable
market. Call option allows a farmer to stake a certain price that he or she would be willing to sell his or her
produce at in order to hedge against a falling market price due to market surplus Most of the producers are
in a very vulnerable position that they would experience devastating losses in the event that producers are
stranded by flood or drought, and this is why the use of the call option comes in. Commodity options in
general acts as hedge tools in the energy sector for instance, in changing the price risk associated with oil,
natural gas, and electricity. Some of these options include: by this, energy companies can employ put
options once prices dip so as to offset this in a bid to retain a certain equity and possibly recover their
profitability of production costs (Giamouridis & Skiadopoulos, 2021). Another usage of options is useful to
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reduce the volatility of the energy prices risks for stabilizing the business operation and formulating a
budget. Based on the analysis carried out above, it is clear that currency options in relation to
commodities have sought to be ingrained in managing Forex risk. From these options, this paper which
Kim, Li, Lu, and Yu, (2022) provides an illustration of how one is hedged against the foreign exchange
exposure, which might cause variation in the cost of imported goods and subsequently an alteration of the
profit margin. A put option is an agreement where the buyer has the right but not the obligation to sell a
specified quantity of a given currency at a fixed price before a certain date; in the case of a weak domestic
currency and strong import dependence, a business can purchase a put option on a currency of a different
country to protect against a decline in the value of the said currency, which is stable and good for imported
goods and long-term cost estimation. Risk management is a dynamic field in the business world and
organizations willing to change their ways in implementing risk management strategies can always find
ways of positioning options to eliminate risks in the constantly evolving markets and also seize any
opportunity of a market in the organizational environment (Kim et al. , 2022).
4.3 Commodity swaps: exchanging commodity price exposure
Commodity swaps refer to transactions which involve the exchange of sales of revenues from a commodity
in one leg of the swap for a fixed cash flow in the other leg of the swap referencing to a floating rate or an
index. It is still seen that there is the interest rate risk in MNCs and they have stressed on foreign
experience in commodity swap transactions (Guo, Xu, & Zheng, 2021). These swaps are used by
company hedgers in managing and linking the commodity price risks with cash flows or other risks in a way
that stabilises firm revenues. Functional uses of commodity swaps Commodity swaps are widely
employed in various industries to hedge impacts relating to risk associated with heightened volatility of
commodities prices. For instance, in a market for agricultural products, farmers can benefit from the
commodity swaps since by developing a prospective false price, farmers will at some point be selling crops
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and have the minimum guaranteed price they expect to be paid. Unless a farmer secures a swap
agreement, he or she is exposed to potential losses as a result of thick or thin grain production, droughts or
markets become oversaturated because the farmer cannot be sure of future grain prices; therefore,
establishing a swap rate will be beneficial in that it will provide a set income in the future. Commodity
swaps within the energy sector enable parties to manage a risk which is known as market risk and which is
experienced as a fluctuation in price with respect to oil, natural gas and electricity. Also, another benefit
that forms part of the energy portfolio management is the cross hedging where the energy companies can
swap on the prices so as to obtain sound outlook on feasible revenues and cash flows (Guo, Xu, & Zheng,
2021). He further explains that when an energy producer enters into a swap agreement, they are paid a
certain level of money, howbeit the interest payment is determined by the market rate, while the up and
coming energy producer gives some amount of asset in exchange for its services; this is helpful in risk
management and long term planning. Besides, the commodity swap is recognized to play role in the
frameworks of the risk hedging in corporations in order to create a value for the shareholders. In this
regard, Huang, Nguyen, and Nguyen, (2022) describe the benefits that may be accrued in managing the
commodity linked risks and level out the financial volatility in such environment. From the prior theoretical
understanding of a swap agreement, I concur with Huang, Nguyen, & Nguyen (2022) stating that an
agreement in a swap allows a firm perfect hedge against such price changes or shocks as they protect
profit margins in order to foster sustainable business growth and development.
4.4 Commodity-linked notes: investing in commodity performance
Commodity-linked notes are fixed income securities and future contracts whose returns depend on the
movement of a commodity index/benchmark or the price of a particular commodity. Halling, Yu, and
Zechner (2020) recognize that leverage dynamics occur throughout the firm life cycle and explain how
CLNs can be applied to control leverage and achieve high risks-adjusted returns. Commodity-linked notes
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are designed in such a manner that their performance is directly or indirectly linked to that of specific
commodities like oil, gold or produce. This means that investors who intend to invest in these commodities
do not necessarily have to own the physical asset, giving them an opportunity to diversify their investment
more so their investment portfolio (Halling, Yu & Zechner, 2020). With regard to potable water market, the
notes primarily provides returns in relation to a commodity index or price indices of selected commodities
so that the investor is able to benefit from future appreciation in prices as well as being shielded from some
of the common risks that are encountered in the potion of single commodities. In multinational
organizations, w fluctuating WE commodity-linked notes are incorporated into risk management tools to
improve financial results and hedge commodity prices (Kundu & Sarkar, 2022). In addition, managing the
duties of commodity prices risk in global commodities is essential for women, and commodity-linked notes
help significantly in this aspect. They provide investors and corporations with various ways to manage the
risks inherently connected with flucations of commodities prices that are pivotal to keeping the financial
world more stable and ensuring the highest efficient return-to-risk ratios (Kundu & Sarkar, 2022). These
financial instruments avails an avenue where the investors can invest in opportunities within the commodity
market alongside bearing the risks that come with such investments hence enabling the investors to avoid
the risks that are associated with investing in the commodity market while at the same time enabling the
investors to maximize on their profits since they are enabled to take on various opportunities within the
market. CLNs are important and useful financial instruments which may help investors to have an
opportunity get the exposure to the changes in the level of the commodity price, to have diversified risk and
potentially to receive higher rate of return. They are incorporated in corporate risk management frameworks
for improving financial performance, managing price risks of commodities, and improving value added
risks-adjusted returns in global environments, hence contributing to the fulfillment of goals of financial
stability and growth.
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5.0 References
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