Foreign Exchange Risk and Management
INDEX
SL.NO. | CONTENTS | 1.2.3.4.5. | INTRODUCTIONFOREIGN EXCHANGE RISKS-TYPES OF FOREIGN EXCHANGE EXPOSURE1. Transaction exposure2. Translation exposure3. Real operating exposureMANAGING FOREIGN EXCHANGE RISKS1.Managing transaction exposure2.Managing translation exposure3. Managing real operating exposureCONCLUSION |
FOREIGN
EXCHANGE RISKS
-MEANING AND TYPES
INTRODUCTION
Foreign exchange risk refers to the risk of an investment's value changing due to changes in currency exchange rates. It is the risk that an investor will have to close out a long or short position in a foreign currency at a loss due to an adverse movement in exchange rates. Foreign Exchange Risk is also known as "currency risk" or "exchange-rate risk”. This risk usually affects businesses that export and/or import, but it can also affect investors making international investments. For example, if money must be converted to another currency to make a certain investment, then any changes in the currency exchange rate will cause that investment's value to either decrease or increase when the investment is sold and converted back into the original currency. It is the risk that the exchange rate on a foreign currency will move against the position held by an investor such that the value of the investment is reduced. For example, if an investor residing in the United States purchases a bond denominated in Japanese yen, deterioration in the rate at which the yen exchanges for dollars will reduce the investor's rate of return, since he or she must eventually exchange the yen for dollars.
In 1971, the Bretton Woods system of administering fixed foreign exchange rates was abolished in favor of market-determination of foreign exchange rates; a regime of fluctuating exchange rates was introduced. Besides market-determined fluctuations, there was a lot of volatility in other markets around the world owing to increased inflation and the oil shock. Corporate struggled to cope with the
SL.NO. | CONTENTS | 1.2.3.4.5. | INTRODUCTIONFOREIGN EXCHANGE RISKS-TYPES OF FOREIGN EXCHANGE EXPOSURE1. Transaction exposure2. Translation exposure3. Real operating exposureMANAGING FOREIGN EXCHANGE RISKS1.Managing transaction exposure2.Managing translation exposure3. Managing real operating exposureCONCLUSION |
FOREIGN
EXCHANGE RISKS
-MEANING AND TYPES
INTRODUCTION
Foreign exchange risk refers to the risk of an investment's value changing due to changes in currency exchange rates. It is the risk that an investor will have to close out a long or short position in a foreign currency at a loss due to an adverse movement in exchange rates. Foreign Exchange Risk is also known as "currency risk" or "exchange-rate risk”. This risk usually affects businesses that export and/or import, but it can also affect investors making international investments. For example, if money must be converted to another currency to make a certain investment, then any changes in the currency exchange rate will cause that investment's value to either decrease or increase when the investment is sold and converted back into the original currency. It is the risk that the exchange rate on a foreign currency will move against the position held by an investor such that the value of the investment is reduced. For example, if an investor residing in the United States purchases a bond denominated in Japanese yen, deterioration in the rate at which the yen exchanges for dollars will reduce the investor's rate of return, since he or she must eventually exchange the yen for dollars.
In 1971, the Bretton Woods system of administering fixed foreign exchange rates was abolished in favor of market-determination of foreign exchange rates; a regime of fluctuating exchange rates was introduced. Besides market-determined fluctuations, there was a lot of volatility in other markets around the world owing to increased inflation and the oil shock. Corporate struggled to cope with the