Foreign Exchange Risk Management

2) Minimize the cost associated with the foreign exchange risk management strategy, i.e. the management and hedging costs

Boral Group has been exposed to changes in interest rate, foreign exchange rates and commodity prices from its activities. Transactions in foreign currencies must be translated at the foreign exchange rate ruling at the date of the transaction. (Boral Limited, 2010) According to the notes of Boral Limited, the sensitivity analysis is used in adjusting the interest rate and currency risks in order to prevent the changes arising from changes of the interest rate and the currency rate from making an impact on the consolidated earnings. For example, at 30

Fluctuations in foreign exchange rates may have an adverse impact on profitability and cause cash flow to be somewhat unpredictable for budget planning purposes.

* Currency exposure is the extent to which the future cash flows of an enterprise, arising from domestic and foreign currency denominated transactions involving assets and liabilities, and generating revenues and expenses, are susceptible to variations in foreign currency exchange rates.

Multinational corporations often sell products in various countries with prices denominated in corresponding local currencies. It is widely recognized that as the volatility in exchange rates has increased dramatically after the breakdown of the Bretton Woods system of fixed exchange rates (Smith, Smithson and Wilford, 1990), multinational corporations may have become increasingly vulnerable to exchange risk since the short term movements in exchange rates are often not accompanied by offsetting changes in prices in the corresponding countries (Shapiro, 1992). Exchange rate exposure is an important source of risk for multinational corporations such as transaction exposure, economic exposure, and translation exposure. Thus, managers of multinational firms employ a number of foreign exchange hedging strategies in order to protect against exchange rate risk. The primary reason companies would hedge foreign exchange risk is so that they do not want to lose money on capital or assets they have stored in different

One way to avoid over-hedging is to hedge only the minimum known payment involved in the future transaction. By hedging a portion of the transactions, a company can reduce the sensitivity of its cash flows to exchange rate movements without creating serious mismatches between the hedge and the risk. In this way, ERM — which consists of managers taking a holistic view of their company’s various risks, prioritizing the material ones, and devising ways to curb them — can help CFOs identify the most volatile foreign exchange rates and reduce some of the guesswork involved in deciding how much of their foreign exchange risk to hedge.

Exhibit 7 from the case study describes the currency development in medium term of the GBP and EURO against the dollar. We can observe that the currencies are exposed to high volatility, which means the company may register greater risk

By minimizing the exchange rate uncertainty, foreign business of the home country is enhanced and can attract more funds as investments. Smoothening currency movements tends to reduce fears in the financial markets and speculative activity that might lead to heavy decline in value of the currency.

The first is transactional risk, which is defined as transactions that lose value due to unfavorable fluctuations of the exchange rate resulting in potential losses for CCE. Our expenses and revenues are not always incurred in the same currencies. We have predetermined profit margin thresholds, and those margins can erode rapidly when the currency we incur our expenses appreciates, or the currency in which we earn our revenue depreciates.

Miller, K. D., & Reuer, J. J. (1998). Firm Strategy and Economic Exposure to Foreign Exchange Rate Movements. Journal of International Business Studies, 29(3), 493-513.

There is a risk that a business ' operations or an investment 's value will be affected by changes in exchange rates. For example, if money must be concerted into a different currency to make a certain investment, changes in the value of the currency relative to the American dollar will affect the total loss or gain on the investment when the money is converted back. This risk usually affects businesses, but it can also affect individual investors who make international investments, also called currency risk (Investorworld).

The exchange rate risk is the risk of an investment's value changing due to changes in currency exchange rates. For example, if money must be converted to another currency to make a certain investment, then any changes in the currency exchange rate will cause that investment's value to either decrease or increase when the investment is sold and converted back into the original currency (Investopedia, 2006). According to Eric Brown, there are three measures of exchange rate risk:

The exchange rate fluctuations brings great deal of uncertainty on profits and costs, hence such risk damages accounting reports, profitability ratings, credit ratings and in the end can bring down the company. There is no question that exchange rate risk has to be managed, and

Currency trading is a very risky venture especially when an investor doesn't understand the market fundamentals. All types of business ventures have associated risks which vary from country to country subject to the financial infrastructure and the monetary policies in place. Other main economic drivers have to be taken into account as they contribute immensely to the stability of the host country's currency against the hard currencies to determine the exchange rates depending on the currency regime in place. Some of the main risks which are associated with currency trading include; volatility, exchange rate risk, credit risk, monetary risk, interest risk and a possibility of government intervention in the financial markets. For purposes of this paper Japan has been picked as the country to be discussed.

The main consequence of an exchange rate fluctuation for international trade is the risk for an exporter or an importer that the cost of foreign currency applied in business volumes will differ from the hoped and calculated. An exposition to foreign currency and a currency risk can make additional profits, and not just losses. However, being in an exposition to currency means relying on a case and most of businesspersons prefer not to allow their company being sensitive to unexpected changes. Therefore, the entities find methods of minimizing or complete elimination of exposition to foreign currency to plan business transactions and to predict profit more authentically (Frieden & Lake 20).