Risk Analysis in Foreign Exchange TransactionsEvery profit maximizing firm finds it vitally important to manage risks of various forms. In every venture, project or investment it would be expected that the management will assess the risk profile involved and based on management perception of risk, make a decision to continue with the strategy, change the approach or quit it. With the business interaction going global, then foreign exchange risk joins the portfolio of risks that modern managers must keep to check. Organizations whether multinationals or not will find themselves in a situation where they have to deal with a currency different from that of the local country.
The exchange rates at which different currencies trade vary by day, season and time, depending on certain economic or/and political forces. It follows therefore, that the firm must undertake measures to eliminate or reduce the effect of this risk and consequently protect the firm’s fortunes (Crabb, 2001). This paper evaluates the objective of foreign exchange risk management and the techniques that organizations can apply to do that. The management of an organization is concerned to fulfill the goal of wealth maximization of the shareholders as mandated by the terms of their engagement.
To achieve this they must prudently analyze risk. One assignment that the management is charged with is preparation of periodic financial reports. These reports involve transactions or ownership of property and real assets in cross border regions where the currency in use is different from the ruling local currency. Some multinational companies have shareholders in many countries. The final books of accounts must be translated into different currencies to serve the differentiated purposes.
The various items of the income statement, balance sheet, and cash flow statements are subject to different foreign exchange risks and hence their treatment differs (Crabb, 2001). This involves managing translation exposure hence risk analysis from the point of view of foreign exchange rate is justified on these grounds. Another objective of risk analysis is to enable management of transaction exposure. The organization engages itself with contractual arrangement involving payment or receipt of cash in foreign currency. Care is needed to ensure that by so doing the does not company suffer losses as a result of fluctuations in foreign exchange.
It implies that one of the requirements of managing business on an international scale is to analyze risk with an intention of identifying the source, extent of exposure, possibility of occurrence and the impact it could have on the organization (Deventer, Imai & Mesler, 2004). Eventually this is done with an intention of making a decision in a professional way as regards to whether it would be rational under the prevailing circumstances to accept that risk. Risk analysis is required to enable the management of economic exposure.
This is embedded upon the concept of future foreign currency cash flows. When parties enter a contractual arrangement to sell and buy an item of value at a future date, there is the complexity of ascertain the monetary value of the item (DeMarzo & Darrell, 1995).