Money. MANAGING FOREX RISK


	COPING WITH RECESSIONS MANAGING PEOPLE GLOBALIZATION AND THE WTO MANAGING FOREX RISK FOREIGN DIRECT INVESTMENT MNC INTERNATIONAL PORTFOLIOS

MANAGING FOREX RISK

The world's currency system is broadly one of "managed floating" driven by market forces. Many countries' currencies, however, are traded in extremely thin and highly regulated markets, throwing doubt on the official rate of exchange. It is sometimes very difficult for a company even to obtain a quotation for these currencies from forex dealers.

If your company does business in a foreign country, it is exposed to three main exchange rate risks.

» Transaction risk: the chance that the exchange rate changes after you have bought or supplied goods and services at an agreed price. This also applies to lending and borrowing abroad.

» Operating risk: your business in a foreign country may be going well, but if there is a crisis (such as the Asian currency crisis of 1997), it will negatively affect your expected future cash flows there. One way to mitigate this is to borrow money in that currency and use your sales income to service the debt – this is called "natural hedging". There are many variations on this approach, such as "back to back" loans, where two companies in different countries lend each other equal amounts in their own currency to be repaid at the same time.

» Accounting risk: US listed companies, for instance, must restate their foreign subsidiaries accounts in US dollars when preparing their group financial statements. There is a risk that a change in the exchange rate could affect the parent's published figures.

A "balance sheet" hedge avoids this by balancing foreign currency assets and liabilities. You can almost never have a balance sheet hedge and a hedge against transaction risk at the same time; faced with a choice, managers tend to prefer to hedge against transaction risk (real cash losses).

Managing forex exposure is a specialized field. A long run of gains in forex dealing can tempt companies to think of their forex managers as a profit center. Continuous selective hedging is essentially increasing risk through speculation rather than trying to reduce it. Firms rarely admit this.