What is financial risk management?

• A. The process of forecasting future profits.
• B. Identifying, assessing, and prioritizing financial risks; example: hedging currency risk with forwards.
• C. A method for maximizing returns without considering risk.
• D. Only about managing credit risk.

Answer: (B)

Financial risk management is the systematic process of identifying potential financial threats, assessing their impact, and deciding how to address them to protect earnings and capital. It focuses on prioritizing risks and using strategies to reduce or control uncertainty, rather than just trying to predict profits. A practical approach is to recognize different risk types—market risk from price movements (like currencies or interest rates), credit risk from counterparties, liquidity risk, and operational risk—and to quantify how bad a loss could be. Then we choose mitigation steps, such as hedging, diversification, risk transfer, or setting risk limits, and continually monitor and adjust as conditions change. A concrete example is hedging currency risk with forward contracts, which locks in a future exchange rate and lowers the potential negative impact of exchange-rate swings. This broader view of risk management contrasts with simply aiming to maximize returns or focusing only on one kind of risk.