Reviews of Foreign Exchange Risk Management

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Published: 06th November 2012
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Exchange risk is logical sequence when conversions of currencies take place like as switching over from one currency to another. Currency exposure is the extent of vulnerability which will affect its profit and loss figures and Balance sheet resulting purely from the exchange rate movements from a Corporate entity point of view. Any large movement in exchange rate in either case would have its impact on domestic currency value of these transactions and if the exchange movements are wide and transactions are large it would have a serious impact on the financial position of the company.It may alter the net asset value and gearing ratio between two Balance sheets dates. The reported profits of overseas subsidiaries can be affected by the change in the exchange rate at which profit figures are translated in to domestic currency in case of multinationals.Hence in a Corporate business strategy, foreign exchange risk management assumes great significance.Foreign exchange rates are always quoted as two way price i.e. a rate at which bank is willing to buy foreign currency and a rate at which the bank sells the foreign currency. Banks do expect some profit to exchange operations and there is always some difference in buying and selling rates. All exchange rates by authorized dealers are quoted in terms of their capacity as buyer or seller.Foreign Risk management means it is taking a view that the future movements of exchange rates will move in its favor. Even if the company wants to adopt the policy of hedging everything, still economic exposure cannot be eliminated and this give rise to opportunity cost. If suppose the company hedged the exposure and if the spot rates moved in favor of the company due to shift in the economic factors between the date of invoice and conversion of currency, the company may lose out or incur and opportunity cost by hedging the exposure if the rates moved against.A corporate can take an up a future contract which is opposite to its foreign currency transaction exposure.

Exchange risk may arise because of exchange rate movements in the period from the original commercial contract, to the time of settlement of the domestic equivalent of the foreign currency amount. A devaluation or rise in the foreign currency against the rupee causes either a windfall or loss to one party or the other involved in the transaction.The exchange rates in India are quoted in a set pattern and before discussing the procedure of calculation of exchange rates it will be necessary to understand certain fundamental aspects involved in this regard.Firms may exercise alternative strategies to financial hedging for managing their economic or operating exposure, by carefully selecting production sites with a mind for lowering costs, using a policy of flexible sourcing in its supply chain management, diversifying its export market across a greater number of countries, or by implementing strong research and development activities and differentiating its products in pursuit of greater inelasticity and less foreign exchange risk exposure.International trade and the other transactions involving cross border flows of funds require the participants to enter the world of foreign exchange. Foreign exchange is defined as claims payable in a foreign country in a foreign currency. Forex trading is very profitable and also can be very risky but there are various foreign exchange risk management strategies, that can be used to limit risk and financial exposure.Investors and multinational businesses 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 if not managed appropriately. Foreign exchange risk is the risk that a business's financial performance or position could be subject to, by fluctuations in the exchange rates between currencies. Such risks are most acute for businesses that deal in more than one currency.

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