Risks in Foreign Exchange Market

Risks in Foreign Exchange Market:

1.Objective:

- Control of foreign exchange risk can be effective if the firm is able to manage the basic relationship between inflation, exchange rates and interest rates.

- The purpose of exposure management is twice minimize exchange losses as a result of currency movements and minimizing the costs of care.

2nd General measures of protection:

a) Invoicing policies:

- Invoices to third parties abroad should be denominated in a relatively strong currency. On the other hand, while imports of goods. Various third parties with the company should try to negotiate payments in a weaker currency.

- The respective bargaining powers and the need for good customer relations have an impact on the invoicing decision.

b) Transfer pricing:
- It is the mechanism by which profits are passed through the adjustment of prices of intra-firm transactions

- It can be applied to transactions between parent company and its subsidiaries or between the strong currency and weak currency subsidiaries.





c) Leading and lagging and extension of trade credits:


Leading: That means accelerating the collection of receivables if the foreign currency in which the invoice is expected to appreciate.

Trailing: it means delaying the payment of obligations invoiced in foreign currency which is expected to depreciate.


There are three elements in this calculation:

- Cash cost / benefit represented by the interest rate differential between lead and member login

- Expected cash profit to realize the changed transaction exposure in those countries, and

- It is expected that translation gain / loss after exposure to altered translation.

d) Netting:
- All transactions gross receipts and payments between parent company and subsidiaries should be adjusted and only the net amounts to be transferred.

- This reduces the cost of remittance of funds, and increases the control of intra-company settlement.

- Also creates savings in the form of a small float and lower costs for exchange.

e) matching:
- It is a process for cash flows in foreign currency are matched with outflows of funds in the same currency with respect, for as much as possible, the amount and maturation.

- When there is cash in a foreign currency cash outflows in other foreign currency, the two may still be the same, if they are positively correlated.