IntroductionForeign transactions are characterized by uncertainties due to changes in exchange and interest rates. Moreover, these transactions depend on events in the host country which include political conditions, economic, social and financial factors. According to Wang (2009), it is revealed that as firms engage in international operations and transactions they encounter increased risk associated with different languages, laws and currencies. However, currency risk presents the biggest threat in relation to foreign exchange transactions. This is because it affects the value of transactions as well as those of the cash flows.
Therefore, evaluating and managing foreign exchange risk is of paramount importance in order to avoid adverse effects that may occur due to changes in exchange rates. This paper is going to explain the objectives of risk analysis as well as the techniques used in analyzing risk. Objectives of Risk AnalysisAccording to Ramirez (2011), the objective of risk analysis in foreign transactions is to safeguard individuals and firms against adverse losses that may occur as a result of fluctuations in exchange rates. Risk analysis enables analysts to identify the amount of risk that a firm may be exposed to in relation to foreign transactions.
This assists in identifying strategies for reducing the risks hence mitigate the losses. Popov and Stutzmann (2006) affirm that the main objective of risk analysis is to minimize and eliminate the losses that may occur as a result of foreign transactions. Foreign transactions are exposed to threats related to unexpected variability in exchange rates. Thus, through risk analysis foreign exchange analysts are able to assess the risks underlying foreign exchange transactions hence identify methods of overcoming the losses that may occur (Brimble at el, 2011).
CPA Australia (2011) notes that risk analysis provides an opportunity through which analysts can identify a no loss position whereby firms can engage in foreign transactions profitably. The evaluation process helps foreign transactions analysts to identify risk management strategies hence reduce the losses that may occur as a result of the transactions. Risk analysis assists individuals and firms in making decisions regarding foreign transactions (Yoe, 2011). Successful foreign exchange transactions are determined by the ability of firms to make decisions that reduce the uncertainties presented by the risks.
Foreign exchange analysts provide firms and individuals with necessary information regarding the risks that they may face in their international operations. This assists them in making decisions that can enable them evade adverse effects that may be presented by the risks. According to Eurasian Group (2010), risk analysis provides information to international firms regarding the magnitude of the risk associated with different foreign exchange transactions. This makes it easy for them to make their decisions regarding the foreign transactions to undertake and those to avoid based on the amount of risk identified.
Risk analysis plays an important role in facilitating firms to make suitable decisions regarding foreign transactions hence this enables them to meet their objectives (Brimble at el, 2011). Popov and Stutzmann (2006) assert that through risk analysis foreign exchange analysts are able to provide information regarding the risk associated with different transactions. The information assists the firms in making effective decisions in regard to foreign exchange transactions.