RISK PLANNING

Risk planning includes:

  1. Strategic alliance: when two or more independent companies come together to achieve a common objective, it is referred to as a joint venture or a strategic alliance. Strategic alliance can be opted when the risk involved is a project is beyond the capacity of a single company. Many competitors are also compelled to work together; this phenomenon is being termed as ‘cooptition’. The partners in a strategic alliance can choose any form of organization; resources are contributed, and management and control is shared amongst the partners.
  2. Long-term arrangements: By entering into a long-term agreement with supplier, lenders, customers and employees; risk can be avoided to an extent. A contract with suppliers ensures the availability of raw material and other inputs, a long-term contract with a lender can reduce the risk of interest rates, a sales contract with buyer can reduce the risk of revenue generation, and a wage contract removes uncertainty to employee cost and labour turnover.

Generally, long-term contracts are indexed, i.e. the prices are periodically adjusted according to the movements in a certain index that reflects inflation. It protects both the buyer as well as the seller. E.g. In a supply contract supply price will be linked with ‘wholesale price index’ in a clause.

  1. Derivatives: options and futures are two derivative instruments used to minimize risk. An option contract gives the owner a right to buy or sell an asset on or before a given date at a predetermined price. It provides flexibility in a rigid or volatile market. The option to buy is called a call option. E.g. In a debt contract with a call option, the issuing firm has an option to buy back the debt instrument when the interest rate falls.

A future contract is an agreement between two parties to exchange an asset for at cash at a predetermined future date and a predetermined price. A future contract minimizes monetary risks. E.g. A refinery may buy a future contract for oil, according to which the refinery will get its supply of crude oil on a predetermined future date and at a predetermined price.

  1. Insurance: insurance provides a cover against risk in exchange of money called insurance premium. One can get protection against risks like theft, fire, loss of key person, physical damage etc. It works as an ultimate antidote against a risk.
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