Managing Exchange Rate Risk - Research Paper Example

The article focusses on different types of currency markets. Thereafter it moves to analyze the determining factors of the impact of foreign exchange rate fluctuations. Next, the article concentrates on analyzing the different type of foreign exchange rate risks and their impact on firms as well as the economy. The paper also provides some remedial measures or risk neutralizing strategies (popularised as hedging). The article provides a brief description of UAE dirham and the consequences it has faced so far due to this fixation with USD.

After having some words on the current volatility of foreign exchange in recent times the article provides a note of caution on the future transaction and a conclusion. This is the era of globalization. Trade is now considered as the engine of growth and the massive increase in global trade volume is a true mark of that. The neo liberals portrays trade as a blessing, but international trade has its own share of evils as well. International trade generally exposes a country to outside risks. This risk comes in terms of demand and supplies side shock as well as the movement of the exchange rate.

Exchange rate movement becomes important as international trade transactions involves two different types of currency at a time. Without a one-to-one parity, their numerical relation is bound to change over time depending upon the economic condition, the politial and social unrest and the exposure to other kinds of risks such as terrorist attacks. Standing at this position, exchange rate risk management is a very important decision making action on behalf of every firm and economy. Through this, a firm decides its level of currency exposure.

Exchange rate risk stands for the unexpected change in exchange rate affecting the value of the firm. It has been found that exchange rate fluctuations impose both direct and indirect loss in the firm’s cash flows, assets and liabilities; net profits and these entire combine in course of time, affecting the stock price of the firm. Previously, it was mostly the MNCs who were exposed to exchange rate fluctuation risk, but as the world moved towards the path of globalization even the indigenous firms started to feel the heat of such risks.

MNCs are the main participants in the currency market and they are not left with many choices because of the nature of their international transactions. On the other hand, the economy itself consisting several firms gets exposed to a greater risk of exchange rate fluctuations as for the economy (all the firms it contains), the risk of the firms get cumulated and stand for the risk faced by the economy.