IntroductionRisk analysis in foreign exchange market refers to the uncertainty of predicted cash flows in the future andinconsistency in stock returns. It also entails analysis of existing statistics to evaluate the probability of business success or failure and probable economic states in the future. The main aim of the analysis is to minimize unforeseen negative impacts in the future. In a broader perspective, an exchange rate risk implies the effect of unforeseen and unexpected changes in the rate of foreign exchange on the real value of an organization or company (Wang, Peijie, 2005).
From this point of view, exchange rate risk is directly equal to the loss due to unmanaged exposure of organizations to risks or indirect losses in the organization’s cash flows, net profit, stock market value, assets, and liabilities. Therefore, considering this point, every organization need to manage its exposure to risks by determining the specific kinds of risks exposed to and determining efficient strategies to encounter these currency risks. Exchange rate risk usually affects multinational companies that deal with export and imports of goods and services. In some other cases, the exchange risk can also affect investors that concentrate their businesses in international investments.
For example, in the case of converting money from one currency to anothercurrency for investment purposes, any changes in the currency exchange rate will result in increase or decrease in the value of the currency when converted back to its original money when exchange rate fluctuates. Objectives of Risk ManagementExchange rate risk analysis forms an integral part and takes center stage in an organization’s decision-making on foreign exchange. The decisions made here aims at formulating strategies of identifying currency risks, strategies to eliminate the identified risks, and the requirement of understanding of how exchange rate risk would affect operations of agents and subsidiaries and techniques to encounter consequent exchange risk implications.
Therefore, almost all sorts of multinational businesses require a vivid risk analysis program. Analyzing risks, measuring them, and formulating strategies to manage them are crucial activities for every company and organization to reduce their vulnerabilities of encountering major changes in the exchange rate markets. This would affect the profit margins and value of assets of the organization exposed to such changes in foreign exchange rates (Pilbeam, Keith, 2006). Selecting the most appropriate and efficient strategies to manage exchange rate risks is a daunting task for most organizations because of the complexities and complications that come with accurate measurement of current risk exposure and making the right decisions on the appropriate levels of risk exposure for analysis. Types of Exchange Rate RisksThere are three major types of exchange rate risks facing most organizations across the globe.
They include transaction risks, translation risks, and economic risks. The difference in the three risks is the degreeof their effects of unexpected changes in the exchange rates on the value of an organization.
Transaction risks involve cash flow risks and entail the impact of exchange rate changes on organization’s transactional account. Risk exposure in this case involves receivables such as export contracts, payables such as import contracts, and repatriation of dividends. In any of these contracts, a change in exchange rate in the currency of any given denomination will definitely lead to exposure of an organization to direct transactional exchange rate risk.