Foreign Exchange Rates and Exchange Rate Risk - Essay Example

The rates therefore are either determined through the market forces or by the central bank of the country to maintain and manage them at a reasonable level. It is also important to understand that when global firms deal in foreign exchange they also expose themselves to various risks. Every firm which deals in foreign currency therefore have to fact these risks and use different hedging methods. These methods vary depending upon the needs of the organization as well as the nature of the transaction.

It is however, critical that each firm has to face these risks and must also manage them in order to avoid losses or reduce the risks and manage it at acceptable level. An exchange rate is the rate at which one currency is actually converted into another currency. It is also the value of currency of one country in terms of the value of the currency of another country. The value of two currencies is mostly determined in the open market in which many buyers and sellers actually determine the value based upon overall demand and supply of each currency.

It is important to note that there are usually 2 types of exchange rates i.e. spot rates and forward exchange rates. Spot exchange rates are the rates which are offered on the spot for the buying and selling of any particular currency. However, forward exchange rates are determined for the currencies to be purchased or sold in given future date. When international organizations actually receive their payments in foreign currency, they contact foreign currency dealers to offer them either spot or forward rates.

Foreign currency dealers however, always quote two different rates i.e. the rate at which the dealer will buy the currency and the rate at which he will sell the currency to the organization. The difference between the bid and ask price (buying and selling price) is considered as the