Book Description

The measurement and management of currency risks has become one of the main tasks of the financial managers in financial institutions and industrial corporations. In general, firms face two types of risks: business or operating risks and financial risks. Operating risks arise as a consequence of the competitive business environment that influences the financial situation of a firm. Movements of exogenous financial variables that influence the financial situation of a firm are defined as financial risks. Currency risk is one example of a financial risk. In this study, it is shown that there are clear differences in the way industrial corporations (should) measure and manage currency risks versus financial institutions. Financial risks can be managed by using the financial instruments available on the foreign exchange market. The primary reason to hedge financial risks is that by doing so firms can concentrate on seeking and managing exposure to those operating risks where they expect to have a competitive advantage. A model is presented to measure the market value impact of risk management decisions. To manage financial risks in practice a cash flow planning model is also derived. Assuming frictionless financial markets, the hedging decisions of financial institutions are not aimed at creating market value. Their main objective is to offer a distribution of returns that fits the preferences of their participants. It is shown how a financial institution can measure and manage the currency risks using such financial instruments as futures contracts and options.