Abstract

Supply chain risk management deals with the identification and control of potential risks along the supply chain.
With business growth and the emergence of new markets presenting new opportunities for companies, the scope of the supply chain has grown along with the exposure to possible risks. The potential for higher gains has paved the way for higher losses too, which might not be sustainable for a business to survive.
Companies face many uncertainties in the form of demand, exchange rates, commodity prices, production, etc., and have started to consider using financial risk management tools such as financial derivatives which were traditionally used by the financial firms.
A literature review of existing material showed the different operational, financial and integrated hedging strategies used and proposed by practitioners and academicians. Surveys covering the use of such financial hedging instrument among non-financial entities showed that these tools are gaining traction. However, they also cite a great deal of confusion among those practitioners on how and when these risk management tools should be used, indicating the need for more research on the topic.
By considering the case of a manufacturer that uses a certain commodity in its production process; a practical guide is developed to assist managers with the decision making process of choosing which financial derivatives, according to the different commodity price scenarios it can face, is the most suitable one that meets their risk approach and financial capabilities.
Through a simulation-based optimization model, the manufacturer is exposed to both price and demand volatility, where four metrics are used to measure the performance of each strategy; the average profit, standard deviation, Value-at-Risk (VaR) and Conditional Value-at-Risk.
The results shed some insight on the use of financial derivatives under different pricing schemes, such as that they perform better when facing high levels of price volatility. In addition to that, financial hedging is more successful when used under a risk averse approach maximizing the profit VaR, than when trying to raise the average return. Financial hedging can still benefit the manufacturer with the risk neutral approach, but when there is a trend in the commodity price.