Managing Foreign Exchange Risks
21 Pages Posted: 21 Oct 2008
This technical note discusses the three types of foreign exchange risk: transaction exposure, translation exposure, and economic exposure. It addresses the nature of those risks and presents some methods that companies might use to manage them. Included in this note are discussions of the financial accounting and reporting requirements of FAS No. 52 (Foreign Currency Translation), of foreign exchange markets, of hedging strategies, and of such activities as loan swaps and licensing agreements.
MANAGING FOREIGN EXCHANGE RISKS
As developments in communications and transportation have increased accessibility to other parts of the world, companies have become increasingly involved in conducting business in foreign markets. Because each country has its own medium of exchange (currency), companies involved in international business must deal with a new dimension not present in domestic activities—that of managing foreign exchange risks. These risks occur because the exchange rates between currencies fluctuate, causing a change in the value of the company's international activities in terms of its domestic currency.
There are three principal ways that foreign exchange fluctuations affect a company's financial performance:
1. By changing the expected results of transactions denominated in non‑domestic currencies (i.e., “transaction” exposure).
2. By changing the domestic currency value of net assets held in foreign currencies (i.e., “translation” exposure).
. . .
Keywords: foreign exchange, international business, international economics, international finance, risk analysis, risk management, international case, diversity
Suggested Citation: Suggested Citation