Introduction :-Foreign Exchange is when we deals on global level means the globalisation of the firm or business. In 21st century it is very much essential for each and every business to expand on global level. The decisions of companies depends on the risk and returns. Due to the differences in the tax structures, exchange rates, policies, interest rates, accounting principles and practices these decisions are very much complicated for the companies.
The various benefits to the companies are:- Ø Increase market for the customersØ Availability of labourØ Availability of high quality materialØ Reduces cost of the production Ø Technology up gradation Etc.With this exposure so many risk are also associated which are faced by every type of business and to reduce these risks businesses have to do risk management because business will accomplish all the goals and objectives with the maximum profit by following the key formula for success i.e. minimum risk and maximum return.Objectives of Foreign exchange Exposure:-ü Take competitive advantage ü Reduce shareholders riskü Increase profit and wealthObjectives of risk management:-ü To minimize riskü For maximum utilization of resources ü To improve the effectiveness and efficiency ü Use as planning tool ü Control cost and activitiesWe have to understand some basic terminologies before understanding about the foreign exchange exposure and risk management. These are as follows:-1) Exchange rate:- exchange rate refers to the value of currency of a country in terms of the value of currency of other counter. In other words the value on which one nation’s currency can be exchanged against another nation’s currency. For Ex.
The higher the exchange rate for one dollar in terms of rupee, the lower the relative value of the rupee which is expressed as $1=?65.2) Spot rate:- The rate which changes very frequently because of the factors, the current market value and the future expected price of the security and non-perishable commodity. The current market value which is acceptable to both the parties’ buyer and seller to perform the transaction. 3) Forward rate:- The forward rate is the rate on which the buyer and seller agreed to exchange the currency on a future date.
In the other sense we can say the rate or value on which the value of one currency exchanged for another currency on a future date. It is used to determine the price of future contracts. It can be higher or lower than the spot rate.
If higher then spot means on premium and if lower means on discount.4) Cross rate:- The price of any currency other than home currency. Cross rate refers to the rate of two nation’s currencies like Euro and Rupee expressed or computed in reference of third nation currency like dollar.
Generally US dollar is used. 5) LIBOR:- ” The London Inter-Bank Offered Rate (LIBOR) is the world’s most widely used benchmark for short-term interest rates. It’s important because it is the rate at which the world’s most preferred borrowers are able to borrow money. It is also the rate upon which rates for less preferred borrowers are based.
For example, a multinational corporation with a very good credit rating may be able to borrow money for one year at LIBOR plus four or five points. The LIBOR is derived from a filtered average of the world’s most creditworthy banks’ interbank deposit rates for larger loans with maturities between overnight and one full year. Countries that rely on the LIBOR for a reference rate include the United States, Canada, Switzerland and the U.K.”Types of Foreign Exchange Exposure 1) Translation Exposure:- Translation exposure relates to the change in accounting income and balance sheet statements caused by the changes in exchange rates. It can be understood that this risk is associated with only those organisations which deal in foreign currency or have foreign assets in their balance sheet.
This is a serious constraint for the global companies. Companies purchase swaps or deals through future contracts to minimise this risk.