Dangers of Corporate Derivative Transactions

Dangers of Corporate Derivative Transactions

WebCPA
(September 17, 2009)
By David Shimko

Excerpts:

By its nature, any derivatives transaction introduces an enterprise-wide risk, even if it has a narrow purpose. Therefore, derivative transactions must be analyzed and managed systematically to ensure consistency with corporate objectives, suitability of the transaction, and avoidance of unintended consequences of the process.

The most important thing for the CFO is to be aware of the dangers in order to manage them. Derivatives comprise a specialized subfield of financial management requiring specialized skills. A CFO with analytic support from people experienced in derivative transactions and risk management stands a better chance of executing derivative strategies successfully than one who does not have this support.

Unfortunately, many CFOs have nowhere to turn but to their counterparties for advice. This is like asking the wolf to guard the sheep. The counterparty has a position of conflict and, even if qualified, should not advise a corporation on derivatives strategy.

Another problem CFOs have is that senior management expect them to have the skills necessary to evaluate and execute derivative transactions, even though this is a highly specialized subfield of financial management. Yet, the best source of advice is an independent adviser who is familiar with the company’s risk policies and profile, and familiar with the markets and instruments under consideration for the hedge.

It is tempting to think that a financial executive need only read a textbook on derivatives to be effective, but this could not be further from the truth. In fact, unscrupulous counterparties can take advantage of executives whose knowledge is textbook-oriented.

Nothing beats practical experience.

Read full article: http://www.webcpa.com/news/Dangers-Corporate-Derivative-Transactions-51729-1.html
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David Shimko holds a PhD in finance from Northwestern University. He has taught finance at the Kellogg Graduate School of Management at Northwestern University, the Marshall School of Business at the University of Southern California, the Harvard Business School, and the Courant Institute at New York University. His professional career included positions at J.P. Morgan, Bankers Trust, and Risk Capital, an independent risk advisory firm that was sold to Towers Perrin in 2006. Currently, Shimko sits on the board of trustees of the Global Association of Risk Professionals. He acts as an independent financial consultant and continues to teach part-time at the Kellogg School.
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http://dreamlearndobecome.blogspot.com This posting was made my Jim Jacobs, President & CEO of Jacobs Executive Advisors. Jim also serves as Leader of Jacobs Advisors' Insurance Practice.