The Effects of Financial Risks on Inventory Policy

Abstract

The effect of financial risks on (R, Q) inventory policies is analyzed in a real options framework. Simple adjustments of the usual formulas for R and Q are suggested and tested. Stochastic demand and purchase costs are considered, both with known systematic (business-cycle-related) risk. The systematic risk of stochastic demand has typically a negligible effect on the optimal values of R and Q, although an improvement may be achieved by a simple adjustment of R. The systematic risk of the purchase price, c, has a significant effect on R and Q. The capital holding cost should be estimated as r \cdot c, where r is the sum of the risk-free interest rate, the expected price decrease, and the risk premium associated with the systematic risk of c. For goods quoted on commodity exchanges, r may be estimated directly from the prices on forward contracts. Its size (and sign) varies considerably for different commodities.inventory control, inventory costing, capital cost and real options

OM Forum—Operations and Finance Interactions

“…These costs should then also be adjusted for market risk. As shown in Berling and Rosling (2005), this adjustment can lead to significant differences in stocking levels depending on the market risk of these costs. This general approach to adjusting cash flows can also allow for efficient valuation of capacity decisions that involve discrete choices such as fixed payments for shifting production from one facility or region to another.…”

Purchasing decisions under stochastic prices: Approximate solutions for order time, order quantity and supplier selection

“…To introduce our modeling of the price process, we assume (as in Berling and Rosling 2005;Li and Kouvelis 1999) that the purchase price per unit satisfies the usual Black-Scholes equation (Black and Scholes 1973), i.e., the price process P = {P (t) : t ≥ 0} is expressed by the stochastic differential equation given by…”

“…Next, the cost is further discounted at a constant interest rate r > 0. This discount rate represents the buyer's opportunity cost of capital (Berling and Rosling 2005;Li and Kouvelis 1999) and is an important part of the cost because some contracts can extend for more than 20 years (Avery et al 1992). Then the discounted total cost C = {C(t) : t ≥ 0} per unit is expressed by…”

“…Dell's announcement in October 1999 regarding the impact of higher-than-expected memory prices resulted in a 7 % decline in its stock value in one day. Berling and Rosling (2005) suggest that systematic purchase-price risk is the major financial risk to consider in inventory control. Prices fluctuate for a variety of reasons, including exchange rate movements, supply disruptions, lack of a futures market, information disclosure, hyperinflation conditions, technical developments, political events, environmental influences, and changing demand.…”

“…They expand the analysis to analyze option contracts for two suppliers, where the total order quantity for these suppliers is fixed and the problem is how to distribute that quantity between them. Berling and Rosling (2005) investigate how to adjust inventory policies under stochastic demand and purchase costs. Paschalidis et al (2004) formulate a stochastic optimization problem to minimize expected inventory costs subject to service level constraints for stockouts and delays.…”