Financial Risks of Recommended Funding Solution

This document discusses the financial risks associated with the recommended funding solution for XYZ Corporation. It covers risks such as credit risk, operational risk, liquidity risk, interest risk, market risk, land valuation risk, and investment risk. The document also provides strategies to mitigate these risks.

What are the financial risks of your recommended funding solution?
Elaborate on how you can reduce or mitigate the financial risk in this project.
Risk Associated with recommended funding solution:
Higher level of LVR (Loan to value ratio) indicates higher level of risk and ultimately larger
loan repayment (What is LVR?, 2014), So, in this case of XYZ Corporation, 60% LVR can be
considered as less riskier compared to 70% or 80 % LVR. Anything above 80% LVR is
highly risky and must be avoided specially in the absence of any guarantor. Besides, any
increase in interest rate could make things even more difficult for XYZ in future. In present
scenario, following risks can be categorized as financial risk for XYZ.
a) Credit Risk:
It can occur due to default in payment of loan amount to bank or financial
organisations. Since XYZ track record is good and they have delivered many such
projects in past. Hence very less possibility of credit risk in case of XYX to happen.
b) Operational Risk:
Operational mismanagement by XYZ can lead to delay in work or stoppage of work
for longer period of time, which can lead to cost escalation of the project.
c) Liquidity risk:
Liquidity risk arise only if fund diverted to any other purpose by XYZ corporation
otherwise it very remote probability to happen this.
d) Interest Risk:
Tight negotiation should be done by XYZ to get fund at minimum interest rate. High
interest rate put lot of pressure on company’s balance sheet. Also, some kind of
hedging can be done by XYZ to protect it from interest rate movement. Due to
monetary tightening by RBA interest rate has gone up. For borrower it will increase
payment obligation and for lender it will reduce their net interest margin (NIM).

e) Market Risk:
Market risk can only be reduced by diversification into various assets class not
correlated to the market like Govt. securities, debt fund, liquid fund, bank fixed
deposit etc. Here, in this case there is provision of at least 40% equity participation
by the XYZ, which is good for project.
f) Land Valuation risk:
Since, valuation of land done by land surveyor of XYZ, hence, value of land could be
authentic; otherwise, overestimation can lead to of higher value of LVR which in turn
put the project under financial risk category. But, XYZ’s past execution record is
good and performance is also good it is less likely to happen.
g) Fundamental & Technical Analysis:
Fundamental Analyst analyses financial statement of company and over all macro-
economic condition of a country and under technical analysis historical price-volume
movement of securities analyse through chart and try to find out most appropriate
valuation of a company. Here in this case XYZ company’s fundamental looks very
good as per XYZ past performance.
h) Investment Risk:
Investment risk can be avoided by putting some investment in govt debt securities for
emergency requirement, so that all of sudden XYZ should not fall short of finance.
This will reduce risk upto certain level it will not entirely removed.
Risk Management:
Risk management is the process in which quantum of risk identified and take measures to
mitigate it ahead of time. It can be said that better performed proactively rather than
reactively. It is like; attempting to control the future possibilities. Risk should be broken
down into manageable parts by XYZ and following measures can be taken:

Financial Risk mitigation strategies:
1. Through the eliminating the root cause risk can be avoided. XYZ management should
work proactively to detect risk and eliminate it then and there. Assessing risk in
advance can reduce financial risk substantially for XYZ.
2. Top management of XYZ should sit together on regular basis and always critically
analyse the progress of the work. Meticulous and detail planning with the help expert
could mitigate the risk. XYZ must Identify all expense before beginning the project
and strictly follow it.
3. Collaboration with bigger firm can diversify the risk; XYZ can find another
financially strong company and collaborate with it to reduce the risk.
4. Contingency allowances can always fall short of expectation, so keep XYZ
contingency fund at appropriate level so that, all of sudden, project worked should not
suffer.
5. XYZ can Transfer the risk through Lender’s Mortgage Insurance (LMI) to protect
from any default. Mortgage insurance can cover in case of the unfortunate happenings
(Tips to Mitigate Risk on Construction Projects, 2016).
6. Try to hedge interest rate fluctuation; it can go up for a lot of reasons. Interest rate
hedging can be executed by XYZ with the consultation of expert; it can be suitable
mortgage products or interest rate derivatives.
7. Accept the risk, only as a last resort. This is just an extreme advise for top
management of XYZ.
It is always easier said than done, but same way, it is always advisable to assess risk before it
actually appeared. And same thing is true for XYZ corporation, If one is prepared in advance
for any accident it always harm you much lesser than it appearance in absence of any
preparedness. Above measures and techniques can be applied to protect and mitigate
financial risks involved in XYZ.

References:
Interest rate hedging, UBS, Available at:
https://www.ubs.com/ch/en/swissbank/corporates/finance/interest-cap.html, Accessed on: 31 May
2019
Market Risk, Syndicate Room, Available at:
https://www.syndicateroom.com/learn/glossary/marketrisk, Accessed on: 01 June 2019
Tips to Mitigate Risk on Construction Projects, (2016), Whirlwind Team , Available at:
https://www.whirlwindsteel.com/blog/bid/407779/tips-to-mitigate-risk-for-construction-projects, Accessed on: 31 May
2019
What is LVR?, (2014) , Your Mortgage, Available at: https://www.yourmortgage.com.au/home-loan-guide/what-is-
lvr/194975/, Accessed on: 30 May 2019
What Is My Loan To Value Ratio (LVR)?, Home Loan Experts, Available at:
https://www.homeloanexperts.com.au/home-loan-articles/loan-to-value-ratio-lvr/, Accessed on: 30 May 2019