International Risk Management

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WORD COUNT: 5452 Words minus headings

Contents

INTRODUCTION

Risk is defined as exposure to uncertainty and a firm’s exposure is controlled by employing risk management techniques. Risk management is a four steps process that entails:

Identification of risks and their causes.

Estimation of the likelihood and impact of risks.

Actions and mechanisms used to minimize risks.

Continuous monitoring of risks and actions to control them.

Exchange rate risk is defined as the variability to a firm’s value due to uncertain changes in the rate of exchange. Exposure refers to the extent to which a company is affected by exchange rate changes and in essence can be termed as the effect of unexpected exchange rate changes on the value of a firm. Exposure is also defined as a contracted, projected or contingent cash flow whose magnitude is uncertain at the moment and is dependent on the value of the foreign exchange rates. Foreign exchange risk management is the process of identifying risks faced by institutions and implementing the process of protection from these risks by financial or operational hedging.

The analysis of exchange rate movements has importance in economics at both the micro and macro level, due to the crucial role currency movements play in macroeconomic policymaking and also in microeconomic decision-making. At the microeconomic level, firms are exposed to exchange rate risk which can adversely affect cash flow and the levels of profiteering, therefore financial managers are regularly involved in exchange rate risk management to secure a firm’s profit.

In international business, investment, financing, and money management decisions are complicated because countries have different currencies, tax regimes, regulations, economic policies, norms regarding the financing of business activities etc. Proper financial management can be an important source of competitive advantage for a firm. Some large MNCs rely upon aggressive trading in the forward foreign exchange market. By trading in forward currencies (future currency) MNCs can provide their overseas consumers with stable long term prices regardless of what happens to the exchange rates. This technique is a derivative tool applied by certain firms to insulate themselves and their customers