6.6 Questions About Hedging, Derivatives, and Trading Risks

Increasingly, companies engage in hedging, derivative, and trading activities that involve substantial risks as part of their overall corporate strategy. Although hedging activities, with derivatives or other tools, may mitigate or resolve risky positions, hedges are rarely perfect. In addition, because of the sophisticated nature of hedging, derivative, and trading activities, the risk exposure of a company is difficult to define, complicating oversight of such activities by a board of directors.

At minimum, the board of a company engaging in hedging, derivative, or trading activities should ask the following questions:

1. Where are the hedging, derivative, and trading risks embedded in the company, and who in the company is responsible for these activities?
2. Does the board of directors understand the nature and purposes of the risk positions being taken?
3. Are there risk limitations in place, and, if so, what are they and how effectively are they implemented?
4. What is the risk to reward ratio that fits into the company’s strategic plan?
5. Does the board of directors have a glossary to translate the explanations that it is likely to receive?