Identify the main sources of foreign currency risk confronting an Essay

Identify the main sources of foreign currency risk confronting an international firm and evaluate different techniques that you think may be most appropriate i - Essay Example It can be seen that due to the volatile and unpredictable nature of the forex markets during times of political or economic crisis both these markets carry a considerable risk for the multinational firms. The preceding discussion will assess the types of strategies which can be used to avoid these risks and their feasibility in the short and long term. This involves the transfer of the transaction exposure to another company through the technique asking them to pay for a product in your currency so that they have to bear the transaction exposure resulting from forex uncertainty on their own. Another technique would be to price the export in the local currency of the other firm and demand payment immediately in which case the current spot rate will determine the value in your own currency of the export.4 A second way of minimising transaction risk is "netting out", and this technique is very helpful for foreign multinationals with large business concerns who do frequent and sizeable amounts of foreign currency transactions. In this way unexpected exchange rate charges will essentially "net out" over many different transactions. This is mainly because when payments and receipts are in many different currencies as this will spread the risks and there might even be a chance of profit.. Although transaction exposure cannot be completely netted away ,the company is better off making a small in one area of trade that a large loss overall if it literally "puts all its eggs in one basket". Compared to hedging this may even be a safer way of avoiding forex risks. Hedging strategies (aimed at reducing short-term transaction exposures of roughly less than a year.5) Forward Contracts This is probably one of the most direct methods of handling hedging risks. The obvious advantage of this is to prevent the company from suffering any loss through a depreciating or appreciating currency because the payment has already been made to a bank. The problem however is that small businesses are often discouraged by banks in this option because of the increased risk that the banks in collecting back the money Futures contracts Another option of hedging transaction exposure is with futures market hedge which is a lot similar to the above method .The difference begins when a short sale of a future contract puts the business in a position opposed to that of a business owning the futures contract. This happens because an increase in the value of the contract causes a loss to the company. 6When the futures contract decreases in value, it gains that amount. Another problem is that any losses in