Exchange Rate Risk Measurement and Management: Issues and Approaches for Firms

22 Pages Posted: 27 Nov 2006

Date Written: November 2006

Abstract

Measuring and managing exchange rate risk exposure is important for reducing a firm's vulnerabilities from major exchange rate movements, which could adversely affect profit margins and the value of assets. This paper reviews the traditional types of exchange rate risk faced by firms, namely transaction, translation and economic risks, presents the VaR approach as the currently predominant method of measuring a firm's exchange rate risk exposure, and examines the main advantages and disadvantages of various exchange rate risk management strategies, including tactical versus strategical and passive versus active hedging. In addition, it outlines a set of widely accepted best practices in managing currency risk and presents some of the main hedging instruments in the OTC and exchange-traded markets. The paper also provides some data on the use of financial derivatives instruments, and hedging practices by U.S. firms.

JEL Classification: F31, G13, G15, G32, M21

Suggested Citation

Papaioannou, Michael G., Exchange Rate Risk Measurement and Management: Issues and Approaches for Firms (November 2006). IMF Working Paper No. 06/255. Available at SSRN: https://ssrn.com/abstract=947372

Michael G. Papaioannou (Contact Author)

International Monetary Fund (IMF) ( email )

700 19th Street NW
10-115
Washington, DC 20431
United States
001-202-623-7799 (Phone)
001-202-623-7018 (Fax)

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