Based on global treasury syllabi from the Association of Corporate Treasurers (ACT) and the Association for Financial Professionals (AFP), this module examines the identification, measurement, and mitigation of the financial risks faced by corporate treasuries .

This lesson establishes the fundamental principles of risk management in the treasury context, distinguishing between different types of risk and explaining why risk management is a strategic function.

1.1 Defining Financial Risk and Its Sources
Financial risk is the possibility of losses arising from changes in financial variables such as exchange rates, interest rates, and commodity prices . Treasuries face three primary types of financial risk:

  • Foreign Exchange (FX) Risk: The risk of losses from adverse movements in currency exchange rates.

  • Interest Rate Risk: The risk of losses from adverse movements in interest rates.

  • Commodity Risk: The risk of losses from price movements in raw materials and other commodities .

1.2 Hedging vs. Speculation
A fundamental principle of treasury risk management is the distinction between hedging and speculation .

  • Hedging: Using financial instruments to reduce or eliminate an existing financial risk. This is the primary purpose of treasury operations .

  • Speculation: Using financial instruments to take on risk in the hope of making a profit. This is not a core treasury function.
    A key objective of adopting a hedging strategy is to smooth cash flows and reduce risk .

1.3 The Risk Management Framework
The ACT syllabus outlines a structured approach to risk management :

  1. Risk Identification: Identifying the sources and nature of the risks the organisation faces.

  2. Risk Measurement: Quantifying the potential impact of identified risks.

  3. Risk Management: Selecting and implementing appropriate strategies to mitigate the risks.

  4. Controlling and Reporting: Monitoring the effectiveness of risk management activities and reporting to stakeholders.

1.4 The Risk-Return Trade-Off
The relationship between risk and return is a fundamental principle of finance. Higher potential returns are only available by accepting higher risk. Treasury decisions must balance the need to protect the organisation from financial loss with the desire to generate returns on its financial activities.

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