Foreign Exchange Risk and Its Management

Abstract

Foreign exchange risk is also known as exchange rate risk or currency risk or foreign exchange exposure, and it is the financial risk posed by an exposure to unanticipated changes in the exchange rates. Investors and MNCs exporting or importing goods and services or making foreign investments throughout the global economy are faced with an exchange rate risk, which can have severe financial consequences on firms’ profitability, cash flows, and their market value, if not managed appropriately. Currency-related gains or losses can have enormous impacts on reported earnings, which affect the firm’s profitability and consequently, the market’s opinion about this firm and its market value, through the demand of its financial assets. MNCs use a number of external techniques of risk (exposure) management and resort to contractual relationships outside their companies in order to reduce (or redistribute) the risk of foreign exchange losses. These hedging techniques are: forward exchange contracts, short-term borrowing, financial futures contracts, currency options, discounting bills receivable, factoring receivables, currency overdrafts, currency swaps, government exchange risk guarantees, and others, which are covered in detail in this chapter.KeywordsExchange RateForeign ExchangeForeign CurrencyCall OptionFuture ContractThese keywords were added by machine and not by the authors. This process is experimental and the keywords may be updated as the learning algorithm improves.