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OPERATIONAL RISK AND RISK CONTROL
ARIZONA STATE UNIVERSITY
IEE 454 - RISK MANAGEMENT
WEEK 5
1.1 Definition of Risk Operational:
In the book Risk Management by Irham Fahmi p.60, it is stated that Operational
Risk is a risk that generally originates from internal company problems, where this risk
occurs due to a weak management control system carried out by the company's internal
parties. Examples of operational risk are computer risk because it has been attacked by
a virus, factory maintenance damage, work accidents, errors in manual bookkeeping
records (manual risk), errors in purchasing goods and there is no agreement that the
goods purchased can be exchanged again, and so on.
A risk manager has identified and quantified the risks his company faces, so he
must decide how to handle those risks. There are two basic approaches to this:
1. Risk control, and
2. Risk financing. Risk
control includes:
1. Risk aversion,
2. Loss control,
3. Separation,
4. Combination or pooling, and
5. Risk transfer
1. Risk Avoidance:
One way to control a pure risk is to avoid assets, people, or activities from being
exposed to risk in the following ways.
a. Refuse to have, accept, or carry out activities even if only temporarily.
b. Give back risks that have already been accepted, or stop the activity as soon
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as it is discovered that there is a risk. So, avoiding risk also means
eliminating it.
c.
Basic Characteristics:
Some characteristics of risk aversion that should be considered as
The following.
1.) There is no possibility of avoiding risk, the more extensive the risk, the greater
the impossibility of avoiding it. For example, if you want to avoid all liability
risks then all activities need to be stopped.
2.) Potential benefits or profits that would have been received from owning certain
assets, hiring certain employees, or being responsible for the timing of activities
will be lost, if risk aversion is implemented.
3.) The narrower the risk, the more likely it is that new risks will be created. For
example, avoiding the risk of transportation by ship in exchange for land
transportation, there will be risks associated with land transportation.
Implementation and Evaluation of Results:
To implement a risk avoidance decision, all assets, personnel or activities that
face the risk to be avoided must be designated. With the support of top management,
the risk manager should recommend certain policies and procedures to be followed by
all company departments and employees. For example, if the objective is to avoid risks
related to ship transportation, all departments are instructed to use other transportation,
such as rail or truck transportation.
Risk avoidance is said to be successful if no loss occurs due to the risk it
seeks to avoid. In fact, the method is not properly implemented if the instructed
prohibitions are violated even if no losses occur.
2. Loss Control::
Loss control is executed with :
a. Lowering the chance of a loss occurring, or
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b. Reduce its severity if the loss does occur.
Both actions can be classified in various ways viz:
a. Loss prevention measures and loss reduction measures
b. According to the cause of the event to be controlled
c. Uncontrolled release of energy as a cause of disaster
d. According to the location of the condition to be controlled and
e. According to the timing.
a. Loss Control According to Loss Prevention and Loss Reduction Methods:
Loss prevention programs seek to reduce or eliminate the chance of loss.
Loss reduction programs aim to reduce the potential severity of losses. Some
loss control programs are a combination of loss reduction and loss prevention
programs. The various prevention programs are illustrated as follows.
The chance of a fire loss can be reduced by construction using fire-resistant
materials. The chance of product liability can be reduced by tightening quality
control, selecting distributors more carefully. Scrutinize the statements made by
salesmen, as well as the advertising section leading to the possibility of
prosecution by consumers.
Loss reduction programs can be further divided into :
1) . Minimization program (preloss program), and
2) . Salvage program (postloss program).
The difference between the two is that minimization programs are carried
out before a loss occurs or during the loss is occurring with the aim of
limiting the magnitude of the loss. For example, fire-fighting measures.
Salvage programs aim to save the remaining property after a loss occurs,
such as property left behind after a fire, and lifting a sunken ship.
b. Loss Control According to the Causes of Occurrence:
Traditionally, loss control techniques are classified according to the approach
taken, namely the engineering approach or the human relations approach.
In some circumstances, both approaches are implemented simultaneously.
The engineering approach emphasizes physical and mechanical causes. For
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example, repairing inadequate electrical wiring, improper waste disposal, and
poor quality building construction and materials.
c. Uncontrolled Energy Release as a Cause of Calamity:
Dr. William Haddon, head of the Insurance Institute for Highway Safety of
America, advocates a more comprehensive way of classifying loss control
techniques based on the causes of accidents. According to Haddo, a disaster is
the result of the transfer of energy in quantity at speed in such a way that it
destroys the structure it strikes. These disasters can be prevented either by
changing the structure of the object with a structure that is resistant to that
energy. To this end, Haddon suggests the following 10 strategies.
1. Prevent the birth of a hazard at the first opportunity.
2. Reduce the number or magnitude of hazards. For example, reduce the speed
of cars and reduce the use of plastic for gasoline storage.
3. Preventing the release of a hazard if a hazard is created, or if a hazard is
already present. For example, prevent infection through milk by sterilizing
the milk before drinking.
4. Changing the speed or force with which the hazard comes out of the source,
For example, utilizing the swift flow of river water so that people can make
several waterwheels.
5. Separating from an object that it can destroy, separation in the sense of
separation of place or separation of time.
6. Separating hazards from objects that must be protected by a barrier, for
example, handling materials containing disease seeds, hands must be given
gloves, avoiding contaminated food ingredients so that food is wrapped or
put in a can.
7. Change the relevant basic quality of the hazard, e.g., that road collisions are
reduced by creating a dividing line between lanes going in opposite
directions.
8. Making the object more resistant to hazards that would damage it. For
example, immunization to strengthen the body against the hazards that
damage it
9. Start taking countermeasures to contain the damage, such as rescue actions
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10. Stabilizing, repairing, and rehabilitating objects affected by calamities
d. Loss Control by Location:
Risk control measures can also be classified according to the location of the
conditions they are designed to control. Dr. Haddon asserts that the likelihood and
severity of losses from traffic accidents depend on the following conditions.
1) . People who use the road
2) . Vehicles
3) . The general highway environment encompasses factors such as
design, maintenance, traffic conditions, and regulations. Haddon's
concept can be extended to other forms of loss as shown in Table 1:
Loss
Location
Fire damage to buildings
People who use the building, and the
surrounding community
Product liability
Users of products, makers of those
products and the legal environment
e. Control by timing
This approach questions whether the method is used
1. Before the accident
2. During an accident or
3. After the accident
This classification has also been used as a criterion to distinguish between
minimization and salvage. Preventive measures (by definition) are all implemented
before the incident. The second classification based on timing also introduces :
1) Planning phase
2) The security-maintenance phase, and
3) Emergency phase
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In the planning phase, consideration is given to making changes where necessary in
terms of loss prevention or loss reduction.
The security maintenance phase includes programs to check implementation
and propose changes where necessary, such as whether the quality of security
services and equipment systems is adequate, to name a few. The emergency phase
includes programs that become effective in an emergency, such as the provision of
fire-fighting facilities.
3. Separation:
Separation here is to spread assets that face the same risk, replacing
placement in one location, for example, if you have many trucks, the separation
action is carried out by placing them in several different pools, placing
inventory items not in one warehouse, but separated in two or more. The
purpose of segregation is to reduce the amount of loss for a single event. With
many independent exposure units, the probability of losses is minimized. Thus,
improving the company's ability to forecast losses.
4. Combination or Pooling:
Combination or pooling increases the number of exposure units within the
control limits of the company concerned, with the aim that the losses to be
experienced are more predictable, so the risk is reduced.
5. Risk Transfer:
Risk transfer can be done in three ways as follows.
a. Property or activities subject to risk can be transferred to another party,
either expressly stated, or hidden in various transactions or contracts.
For example, a company that sells one of its buildings has automatically
transferred the risks associated with the ownership of the building to the
new owner. There are companies that hand over part of the company's
activities to contractor. This also means transferring any risks associated
with the work.
b. The risk itself is transferred.
For example: in a building rental case, the tenant may be able to shift to the
landlord the responsibility for damage to the building due to the tenant's
negligence. Another example, a manufacturer may be able to induce a
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retailer to assume responsibility for the acceptance of damage to goods,
which occurs after the goods have left the manufacturer's warehouse, even if
the manufacturer is actually liable.
In each of the examples stated above the transferee forgives the transferor
of liability. Therefore, the exposure itself is eliminated. Some risk controls
do not eliminate the exposure, but only limit it. For example, the exposure
only limits the dollar amount of liability, not eliminates it.
c. A risk financing transfer creates a loss exposure for the transferee.
Cancellation of the agreement by the transferee can be viewed as the third
way of risk control transfer. With the cancellation, the transferee is not
legally responsible for the loss that it originally agreed to pay.
1.2 Forms of Risk Operational:
There are several factors that can influence the formation of operational risk,
That is:
a. Computer Risk
Risks in the computer field usually occur due to various factors such as the entry of
viruses caused by inadequate software protection. In a company, the need for an IT
(information technology) who has adequate quality and competence, even if it is
necessary to have a reputation is very necessary. In this era, every advancement in
software technology is always followed by various problems that arise. Hackers are one
of those who are so interested in working in the software field and trying to break
through every protection made by an institution. Which is no exception is a banking
institution as in the case of ATM break-ins using fake ATM cards, the creation of a
fake banking website so that customers are fooled and many transfer money to the fake
website.
Every company that has a direct relationship (connect) with the internet means that
various company information can be directly absorbed by various parties outside the
company, especially those who use the internet network. One case that has shocked
many parties is "Y2K" which will occur when the year 1999 moves to 2000. The
problem is that so far computers have been accustomed to recording 1900 to 1999 and
then have to change the beginning by 2000 and the final number is 00 instead of the
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digit 99. This interpretation made many parties confused, so that this response had a far
charge including estimates of changes in accounting programs and so on.
Therefore, there are several risks that are expected to arise in the computer field,
namely:
1) The occurrence of changes in computer data due to factors attacked by viruses. This
condition often occurs because computer networks must always have the latest anti-
virus. So instead the company must always have a special safe place to store important
documents. To secure some important documents, there are several actions that must be
taken by the company, namely:
⮚
Separating data that is considered important and less important, such as by
contains important and unimportant data. If necessary, store it in two places, both in
office A and office B with the aim of avoiding unexpected things, for example, fire,
theft, and so on.
⮚
Building protections for data and other information, such as by making
Special passwords and only certain people can know.
2) Computers are a technology that always changes, especially in every program
offered, so it requires the IT quality of its personnel to be updated every time with the
aim that various problems that will arise in the future can be avoided.
3) Computers are included in the IT category which has a high market value, so every
change of computer equipment and the cost of experts always costs money.
high. Such as training costs, courses, computer services, and the purchase of various
computer programs. And for every company the program that must be purchased is
always original.
According to Husein Umar, there are several main causes of computer system
damage, as well as identifying the consequences of common computer damage,
namely:
From the table above we can see that hardware/software damage and fraud, theft
are the highest at 30% (thirty percent).
b. Factory Maintenance Breakdown
For every company, especially companies that have machines that rely heavily on
the quality of their equipment in supporting production, the costs of maintenance,
maintenance and replacement of factory equipment are routine. Equipment or factory
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maintenance when viewed in terms of market prices have different values, there are
low, medium and high. As well as further there are those that can be obtained in the
country there are those that must be imported. if it must be imported, it means that the
company must provide foreign currency to be able to order and purchase the
equipment. as well as the technicians needed to operate the factory machinery must
also be trained in advance, schooled in order to properly understand any problems that
arise in the future.
Therefore, some of the risks that must be borne by an industry when a plant
maintenance breakdown occurs are
1. The cessation of production activities for a while. It is endeavored that the
suspension of production activities does not take a long time, for example, up to days,
so that it can further disrupt any orders that have been received.
2. Service costs by bringing in experts, if the company does not have them.
3. Replacement costs in the form of new purchases of some factory equipment. And a
further problem if the ordered goods are not available in the market quickly, thus
requiring the company to order in advance and this will take a long time.
c. Work accident
Work accidents occur when a company does not implement and enforce a concept
of safety and work guarantees in accordance with applicable rules and regulations.
Sometimes some companies do not heed and apply the concept of safety and job
security in accordance with the provisions, with the aim of avoiding spending costs.
The cost avoidance includes several things such as:
1. Insurance costs for each employee that must be paid monthly.
2. Dependent costs when employees have an accident and the insurance company has not
submitted or has not issued the submitted insurance claim. So that waiting the process
of issuing insurance claims causes the company to have to bear temporarily.
3. If the rules on work safety guarantees and concepts are included in every employment
contract with employees, then if the company does not comply with the agreement, it is
possible to be sued or brought to court at a later date for breach of contract and must
pay compensation in the amount requested by the plaintiff.
On the basis of the above analysis, we can conclude several risks in the field of
accidents that will be experienced by a company, namely as follows.
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1. The company must improve the work management system that has been implemented
so far because it is considered ineffective, so to perfect the concept of a good work
management system a company sometimes has to invite consultants in the field
concerned so that the budget allocation to pay the consultant must be considered
including the trial period of the system.
2. If work accidents occur frequently and are often highlighted by the press, this can
result in a decline in the company's reputation in the eyes of consumers and business
partners.
3. If the company does not apply the concept of work safety properly, then when applying
for a loan to the bank, there will be problems. The problem arises if one day a work
accident and various other problems arise such as a lawsuit from the employee so that it
is estimated that this can have a good effect on banks because they make decisions to
channel loans (credit) to companies that are considered unfit.
4. The number of workplace accidents every year is always announced either by the
government or by the print media. This information spreads throughout the world so
that the image of the company, especially the government concerned in the eyes of the
international will experience a decline in reputation, even further this can be raised as
one of the political campaigns of the opposition to corner the government concerned.
d. Error in Manual Opening (Manual Risk):
Risks in the field of manual opening actually occur for several reasons such as:
1. The opening is manually written or recorded generally on paper, so that when an office
experiences flooding, fire, errors in it can not or difficult to find a replacement.
2. If an error in bookkeeping occurs, then solving and finding the source of the problem
must also be done manually. Such as errors in the preparation of the income statement,
the tracking process where the source must be searched in books or records and also
tracing must be done to the journal book as well as on each receipt and various other
written evidence. so that if this incident often occurs, the time required is too long.
indeed one of the advantages is that physical evidence is immediately found. However,
if this is done by computer, then by simply looking at the serial number of each check,
invoice and so on it will quickly be completed. if done by computer, the company can
create a website or private office email that is confidential and stores confidential data
with a secret password as well, so that if a leader is out of town or out of the country
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then with data stored via the internet it allows work to continue and various data can be
easily obtained.
3. The process of preparing the bookkeeping will take a long time so that the work
becomes inefficient and effective. efficient in terms of cost and effective in terms of
time.
4. Every delivery of information must be made through the post office or mailing service,
while the use of technology can be done by email or via the internet.
e. Error in purchasing goods and no agreement that the purchased goods can be
exchanged back:
Risks like this arise when the agreement in every purchase of goods is not followed
by an agreement that the goods can be exchanged again and various other agreements.
So that when the agreement is not made, the company must experience or bear several
risks of loss, namely as follows:
1. There are goods that have been purchased with the hope that they can be sold but are
not sold and there is no agreement that the goods can be exchanged so that the
company suffers losses.
2. When the goods have been sold but it turns out that there are leftovers and it cannot be
exchanged for a new one, then this forces the company to sell it at a low price with the
assumption that the goods are not sold in the market or expired.
3. The company cannot make cost savings because trade contracts with business partners
are cash and there is no concept of after-sales service.
1.3 Employee Outsourcing:
The recruitment and placement of employees under the concept of outsourcing has
a major influence on the company both in the short and long term. Outsourced
employees are usually employees provided by an employee provider organization and
then a company contacts the company to be employed as a contract at the company, or
a company as an employee with an outsourcing agreement. At present many companies
are implementing an outsourcing system for various reasons, namely as follows:
1. The costs incurred are cheaper because the company only needs to contact the
employment agency. If the company has been doing it on its own, such as creating an
employee recruitment and selection team and also making training, then the existence
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of labor channeling services allows the costs incurred for that to be less.
2. Employees who come from outsourcing are considered more prepared because they
have been prepared.
3. The company only owns and is responsible to the labor channeling agency and it is
done in accordance with the agreed cooperation contract.
4. There are no fixed costs that must be borne and prepared, such as when the employee
will retire, he must prepare severance pay or pension funds.
5. The company can easily replace the employee after the contract period expires because
the agreement is made in accordance with the contents of the employment contract.
When a company accepts outsourced employees, there are several risks that must
be borne by the company, namely:
1. The employee is not a permanent employee, in the sense that the employee does not
work until retirement. So he will work only for the duration of the employment
contract. Therefore, the psychological sense of responsibility for maintaining the
company does not really matter because the employee is more responsible to the
channeling company.
2. It is possible for the company's secrets to become known to the outside public when
they no longer work for the company. Meanwhile, company secrets are related to the
prestige and good name of the company.
1.4 Globalization in Concept and Product:
The era of globalization has given a big change to the concept of business concepts
in all business sectors, both financial and non-financial, so that the creation of product
concepts is made to accommodate the wishes of globalization, otherwise it means that
the product will not sell well in the company. Today's society is a form of global
society structure that uses global products and applies global thinking.
Because of this factor, companies are required to implement management based on
global concepts, which indirectly means that the company's operational mechanisms
must also be global. To realize this, it is necessary to conduct training and education for
employees in order to know the concepts and ways of thinking globally which will later
be contained in the form of product results.
To implement the global concept, the company must quickly adapt in adjusting any
current changes to the reality conditions in the company. Such as the use of modern
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technology that has high specifications so that it is quickly connected to various
problems, both problem complaints that come from internal companies and those from
external parties. So that there is no accumulation in handling problems, but problems
will be resolved more quickly.
Therefore, the application solution that must be applied is, "Thinking, planning, and
realizing all business activities by applying international standards, especially activities
related to aspects of capital, regulation, transparency or communication, technology
and the competence of management and employees. So that with such an application It
is expected that the company's anticipation of operational risks from a global
perspective will be avoided or at least minimized.
1.5 Risk Measurement Operational:
According to Mamduh, one of the techniques to measure operational risk is to
use two classifications as follows:
1. The frequency or probability of the risk occurring.
2. The seriousness of the loss or impact of the risk.
We can measure operational risk by placing the level of each form of risk that occurs,
namely the higher the risk, the higher the possibility of obtaining the expected return
(actual return), assuming risk and return are linear. For more details, we can see in the
figure below.
Description:
E(R) = Expected return or expected profit
δ = Standard deviation or standard deviation. The standard
deviation here is often interpreted as the level of risk, the
greater the standard deviation, the greater the level of risk that
will occur.
In the figure above, we can understand that there is a strong relationship between
E(R) and δ. Where each point and region can be explained as follows:
1. Position I is where E(R) is at the highest position and δ is also at the highest position
in the sense that the higher the expectation on E(R), the higher the possibility of δ. Or
in other words, here the expected return maximization condition is linear with the risk
that will be accepted. For example, when a company plans to increase production
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capacity, the possibility of increasing sales will definitely occur or the company's profit
will increase, but this also results in an increase in the production process to be able to
increase the amount of production per unit, namely if previously the company could
produce 4,000 units, it must now be increased to 4,700 units. This condition will have
several impacts on the company's operational risks such as:
a. Production machinery will experience an accelerated depreciation period because it is
used for a longer period of time and is chasing production targets.
b. The need for raw materials required will experience a high increase and must not stop
because it will affect the smooth production in a timely manner.
c. The availability of manufactured goods must always be available in the warehouse
because it is related to the smooth flow of orders from distributors or buyers, because if
this is congested, customer satisfaction will be disrupted.
2. Position II is where E(R) is in a low position and δ is in a high position or in other
words E(R) and δ are non-linear. This position requires a company to anticipate and
implement a maximum strategy to avoid a higher risk increase movement, because the
higher the risk that occurs will cause several things to the company such as:
a. The increase in the company's losses will continue to grow and further deplete the
reserve fund.
b. If this risk of loss is allowed to continue, it will cause the company to be in financial
distress.
c. The credibility and reputation of the company will decrease because various parties
ranging from business partners to consumers, especially actual consumers, will be
increasingly disappointed.
d. Furthermore, it can lead to the risk of bankruptcy.
3. Position III is where E(R) is low andδ is linear.
4. Position IV is where E(R) is in a high position and δ is in a low position or in other
words E(R) and δ are unidirectional (non-linear). In this condition there are several
conditions and situations that need to be observed, namely:
a. Risk is very difficult to predict but if it occurs it can put the company in point / position
II.
b. These conditions and situations occur when risk control becomes weak because the
company has been lulled by profits (returns that continue to increase).
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c. The spirit of working under pressure carried out by the company management is no
longer like being in position II, and this can have an impact on reducing work
discipline and work targets that must be done.
5. Position M is the position that is considered the most optimal point for the conditions
of E(R) and δ. If the management and commissioners of the company (shareholders)
want a stable condition in the sense of safety position, then they should choose position
/ point M only.
1.6 Cost to Risk Operational:
To overcome operational risk, a company must make an analysis that includes:
a. Calculate and map the forms of risks that are and will be faced.
b. Calculate how much money should be allocated regarding risk management.
c. Decide on the establishment of an appropriate mechanism to manage risk.
d. Decide on the source of funds that can be allocated to support the resolution of this
operational risk.
1.7 Operational Risk and Working Capital:
Understanding operational risk has been discussed above in depth, so it is good to
also know the definition of working capital. Working capital is the funds spent by the
company to finance operational activities every day, such as buying raw materials,
paying employee salaries, paying employee salaries, labor wages, paying electricity,
paying telephone bills, cleaning costs, and various other expenses. Where every
expenditure made is recorded and recorded in detail.
The purpose of making the bookkeeping is:
a. Can be used as an accountability report to company leaders.
b. Can be used as a predictive tool in estimating various company needs, especially for
the long term.
c. As a guide for various interested parties to see the condition of the company in
carrying out its activities. Such as students who are doing KP (practical work) and
other researchers.
d. As one of the recommendation materials in decision making for an investor.
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FOREIGN EXCHANGE RISK AND FINANCING RISK
2.1 Understanding Foreign Exchange Risk
Risk can be interpreted as a form of uncertainty about a situation that will occur
later. While the definition of foreign exchange is a currency that is recognized, used,
used, and accepted as a means of payment by many countries in international trade.
Thus it can be concluded that the definition of Foreign Exchange Risk is the
uncertainty of the value of a country's currency used as a means of payment in
international trade.
According to (Irham Fahmi, 2016, 85) Foreign exchange risk (forex) is a risk
caused by changes in foreign exchange rates in the market that are no longer as
expected, especially when converted to domestic currency. This is caused by changes
in foreign exchange rates in the market that are no longer as expected, especially when
converted to domestic currency.
Example: Suppose on October 10, 2016; 1$ USA = IDR 1,000.00. On October
15, 2016; 1$ USA = 1,150.00. Then the increase of 1$ USA for 5 days is IDR 150.00.
2.2 Avoiding Foreign Exchange Risk
In this era of globalization, financial activities no longer recognize borders,
allowing various parties to be involved.
To avoid foreign exchange risk, three ways are usually used by banks, namely:
1. Accounting/translation exposure
Accounting/translation exposure, which is a policy to convert the company's
assets and liabilities in the form of long-term foreign currency into the domestic
currency of the country concerned. Accounting/translation exposure arises
because the financial statements of foreign branches, which are denominated in
foreign currencies, must be converted into the reporting currency of the parent
company to create a consolidated financial statement. For example, the financial
statements of a foreign-currency branch are converted to the parent company's
financial statements in local currency.
2. Transaction exposure
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Implementation of Transaction exposure, namely conducting policies in
the form of treatment of foreign exchange income and costs in the
upcoming book and then analyzing its effect on net income for potential
changes in foreign exchange rates.
For example, an importer company A based in Indonesia has a debt to its
supplier company B based in the US denominated in dollars. Company A
experiences uncertainty because when they have to pay the debt in the future
the currency exchange rate may change.
3. Economic exposure (operating/competitive exposure)
Implementation of Economic exposure (operating/competitive exposure),
namely conducting in-depth research and analysis of foreign exchange trends
that occur in the future.
For example, an Indonesian company has a branch in the US. The branch
produces goods that will be sold in the US domestic market. A significant
proportion of inputs come from Indonesia. Then the dollar depreciates
significantly against the rupiah.
2.3 Company Anticipation in Facing Foreign Exchange Fluctuations
A company takes several decisions to protect its business activities from
fluctuating conditions that can have an impact on company losses, namely:
1. Avoid purchasing goods in foreign currency if it is not necessary.
2. Avoid buying new goods even if the price is low, because in fluctuating
foreign currency conditions it is possible that the goods will again be much
cheaper as the value of the foreign currency decreases.
3. If there are items in the warehouse that have a high selling value in the
market and the number of these items is considered ineffective. In the sense
that rather than being stored in an amount that If there are many items in the
warehouse and the company needs funds, it is better to sell them and replace them
with something else that has a high selling value.
2.4 Advantages and Disadvantages of Forex Movements :
In general, gains and losses stemming from foreign exchange rate movements are
required as follows:
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1 Transactions resulting in a gain or loss are translated at the average currency
rate prevailing during the year.
2 Assets liabilities in the closing balance sheet are transacted at the exchange rate
prevailing on the closing date of the statement.
3 Net assets on the opening balance sheet are restated at the closing exchange
rate, i.e. the difference from the previous year will be included in reserves.
4 Exchange rate differences on foreign currency borrowings that are directly
raised or hedged against overseas fixed assets will be included in reserves and
will be offset against exchange rate differences on those assets.
5 All other gains and losses have been included in the income statement.
2.5 Definition Insurance:
Insurance can be defined from two points of view. First, insurance as protection
against financial risk provided by the insurer. Second, insurance is a risk pooling tool
from many people or companies through actual or promised contributions to form a fund
to pay claims. From the insured person's point of view, insurance is a risk retention and
risk combination tool. The special features of insurance as a means of risk transfer are
that insurance requires pooling of risks, i.e. the insurer combines the risks of many
insureds. Through this combination, the insurer increases its ability to forecast expected
losses.
1. Insurance is not gambling
Sometimes the purchase of insurance is confused with gambling. Both insurers share
one characteristic. Typically, the insured and the gambler may both receive more
money than they paid in, the outcome being determined by chance events. However,
through the purchase of insurance, the insured transfers pure risk, whereas a gambler
creates speculative risk.
2. Difference between Insurance and Bonding
From the obligee's perspective, the protection provided by surety bonds is insurance-
like. Furthermore, an incorporated surety is considered an insurer in legal terms. In most
insurance companies, large losses have their own bonding department.
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Not all property insurance contracts nor all surety bonds share the
characteristics listed above. Some surety bonds resemble insurance more than others.
However, this distinction between genuine property insurance contracts and genuine
surety bonds is valid and useful. One type of surety bonding, fidelity bonding, is so
different from the other types, it is usually considered a separate class. Fidelity bonding
protects an employer against dishonest acts by its employees. Most fidelity bonds
closely resemble insurance and are commonly referred to as dishonesty insurance.
Originally, fidelity bonds were written on the same basis as surety bonds. According to
these less common fidelity bonds, there are three parties to the contract, namely the
employer, the employee, and the insurer or surety. The employee signs the contract and
pays the premium, but it is the employer who obtains the protection. The insurer will
investigate the employee by scrutinizing before writing the bond.
2.6 Benefits and Costs Insurance
Insurance, like most other institutions, presents the public with benefits and costs.
1. Benefits
Actually, the benefit of insurance is to compensate those who suffer unexpected
losses. They are restored or at least to change their previous economic position. The
benefits to these individuals are obvious. Society also benefits because these people are
restored to production again, tax revenues are increased, and the welfare funds that the
government has to pay are reduced Insurance reduces uncertainty. A more meaningful,
but less tangible benefit of insurance arises from the fact that it can reduce uncertainty:
a) eliminating the risk of uncertainty. as well as personal reactions, such as
anxiety, to the risk for the individual insured party.
b) reduce the total risk, uncertainty, as well as the adverse reaction to this risk
in society.
The insurer bears a large amount of risk, but depending on the experience of
many insureds, actual losses are likely to be covered by expected losses. In practice,
the insurer's uncertainty, while smaller than that of the insured, is not as small as the
previous discussion implies. The difficulty is that the insurer does not know the exact
expected loss. The insurer must estimate it, and as a result of having some uncertainty
about how close the actual loss will be to the expected loss, the insurer does not have
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perfect confidence in its estimate of the expected loss.
a Insurance Companies as a Source of Funds for Investment
Insurance companies, as non-bank financial institutions, are able to mobilize
funds available for investment outside of insurance, not only because of the low risk
but also because there is a cash income so that the amount of money available always
exceeds the reserve for paying claims. In 1953, life insurance provided approximately
7.5% of the funds traded in the money and capital markets and 14.1% of the long-term
funds increased in these markets. Loss and liability insurance plays a lesser role in the
capital markets than life insurance. This is mainly due to the fact that liability
insurance contracts are shorter in duration and consequently liability insurance
companies accumulate less funds from premium collection.
Nonetheless, the contribution of casualty and liability insurance in providing
investment funds is quite important. Self-employed pension insurance within
companies (which is insurance too, if you look at it from the employees' point of
view) also invests its funds through the capital market. Likewise, public employee
pension insurance (TASPEN) also throws its funds into the capital market.
b Loss control
Although loss control is not an inherent part of the concept of insurance,
insurance companies were pioneers in loss control. Trade unions and individual
insurance companies are both involved in various loss control activities. Some of
these have been discussed in "responsibility for loss control". While it is known that
the contribution of insurance in this field does exist, it is expected that it will play a
greater role in the future.
c Support for Small Companies
Insurance increases the competitive spirit, because without insurance companies,
small companies will face a less effective competition against large companies.
Large companies can safely cope with some risks, but if such risks are transformed into
losses, they can destroy small companies. Without insurance, small companies will
bear some risks and will be less attractive to invest labor and capital in the company.
d Summary of Benefits
In short, it can be concluded that the benefits offered by insurance companies are
as follows.
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1. Protecting loss for people who suffer loss of expectation.
2. Reducing mental and physical torment for the insured party caused by fear and
worry.
3. Generate optimum production levels, price levels, and price structures.
4. Provide funds for investment.
5. Improving the competitive position of small companies activities. In addition,
insurance companies in practice also take part in important loss control
activities.
2. Fees.
Although the benefits caused by the existence of insurance companies are quite
large, insurance also incurs costs.
a) Operation Cost:
Insurance creates costs such as loss control costs, loss adjustment costs, costs
incurred to find potential insureds, premium taxes set by the government, and
general administrative costs. The costs incurred, plus a certain amount of profit
and reserves, must be covered by the premium that is paid charged. In reality,
workers and other resources that may already be tied up in other uses are also
needed by insurance companies.
b) Moral Hazard.
The second cost in the insurance industry is the creation of moral hazard. Moral
hazard is a situation where there is an increased chance of a private person
deliberately causing a loss or increasing its severity. People who do not heed
morals or they believe that they can make a profit through loss creation.
c) Morale Hazard.
Another related cost is creating morale hazard. Morale hazard is a situation that
causes people to be less cautious than they would otherwise be. People
unconsciously create losses because they feel they are insured. Little difference
exists between morale hazard and moral hazard created by the insurance field,
but all agree that people's actions are influenced by their own attitudes and
morale hazard is more common than moral hazard.
d) Cost Reduction
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These costs created by the insurance industry far outweigh the benefits
mentioned above. The appropriate course of action is to reduce costs. Insurers
are constantly trying to reduce costs through innovations in things like
administrative procedures and marketing methods.
2.7 Investment Risks from Hot Money:
Hot Money is the term most commonly used in financial markets to refer to the
flow of funds (or capital) from one country to another for short-term gains on interest
rate differentials and/or anticipated exchange rate swings. Hot Money can move very
quickly in and out of the market, potentially causing market instability.
Conditions that always try to create comfort so that the entry of foreign
investment into the country must actually be done carefully and full of deep control.
With the aim of avoiding various kinds of unwanted problems in the future such as the
influx of hot money. Which means that these funds enter and may suddenly be
withdrawn by their owners.
In this hot money problem, the party with the most responsibility to create
conditions conducive to domestic and foreign exchange rates is Bank Indonesia as the
monetary authority. The policy that must be made by Bank Indonesia is to make a
strong effort to eliminate the dependence of BI monetary policy on short-term foreign
fund flows (hot money).
Another policy that must be taken and applied is to determine and apply to
domestic and foreign investors who want to invest must have a strong spirit to always
maintain and maintain the spirit of nationalism and love for the country.
2.8 Risk of Debt in Foreign Currencies :
In terms of the concept of capital structure (capital structure) emphasizes that if
the debt is very should not exceed the limit of shareholder'sequity (wealth owned).
However, if it turns out that the debt has exceeded the shareholder'sequity limit and
cannot be paid anymore, then that is what is called a banking case as bad credit.
Borrowing in foreign currencies may be considered a much lower interest rate
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compared to seeking loans from domestic lending institutions such as banks. However,
it must be understood that foreign currencies often experience movements of instability
due to many factors such as the implementation of the floating exchange rate (floating
currency system) implemented by Bank Indonesia in its monetary policy.
The situation of loans in foreign currency becomes worse if the loan is mostly
used for business in the country and the market share is also in the country. so that when
the foreign exchange rate fluctuates, such as the low domestic rupiah compared to
foreign currencies, namely the US dollar, and entrepreneurs have to return the loan at a
loss, so if this happens continuously it will cause the organization to go bankrupt.
2.9 Reasons for Using US Dollars in Business Transactions :
There are several reasons why the US dollar is used as a measuring instrument in
payments, namely:
1. The stability factor of the dollar compared to other currencies around the
world.
2. The factor has been the frequent use of the dollar as a means of payment for
international trade transactions.
3. The stability factor of the American economy is considered by many
observers to have a stronger level of stability than many other countries.
2.10 Consequences and Risks Arising when the US Dollar is Used as Medium
of Business Transactions:
International trade transactions and payment agreements that are applied in the
form of US dollars will automatically cause several excesses as follows:
1. A higher than normal increase in US dollar traffic due to high usage.
2. The need for the US dollar is dominant. Because the dolla currency is used
as one of the reference currencies to see the exchange rate. So this condition
causes many parties to need the US dollar.
3. The fluctuation of the US dollar in the market. At the time of economic
turmoil in the United States, various countries that have been using the US
dollar as a means of measuring domestic and foreign currencies will also
experience strong shocks.
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4. Banks must have sufficient US dollar reserves in the market. If it does not
have sufficient US dollar reserves when the dollar is high in the market, the
company does not have to buy dollars because the need is already available
in cash.
5. The policy of the federal reserve or central bank of the United States is very
important to observe. Where various parties both business people and other
traders must always pay close attention to the various policies of the
American central bank, and if the analysis of the various federal reserve
policies is not carefully and deeply considered, it means that the company
may make the wrong decision.
6. The United States dollar currency is no longer considered as a transaction
tool but further than that, namely as a commodity for profit, namely by
buying dollars at low prices and selling them at high prices.
