Question

Exchange rate risk:

The value of currencies changes every minute. Over a month, or indeed a year, the value of a currency can change enormously. This represents an exchange rate risk to exporters and importers, and can have important implications for a company profits.

Use a numerical example to explain how large firms protect themselves from exchange rate risks.

Answer 1

An unexpected currency fluctuation is very crucial for companies.An Unanticipated exchange rate change affects companies competitive position with other companies,It's profit and also market share.MNC's,Large companies and small enterprises also facing this situation.An exchange rate fluactuation affects market value of the company.So,companies are always alert about this situation.Exchange rate variation happens due to inflation,balance of payment crisis,terms of trade,interest rate changes and recession.Exchange rate variation can happen any time.So,firms protect themselves from exchange rate risks.The following are the major measures which is used by firms to meet exchange rate risk.

• Evaluation of the process and speculate the point which happens exchange rate fluctuation.
• Hedging(spot contract)

Mainly firms hedging for meet exchange rate fluctuations.ItForward contract can be used for hedging.For example,If amill owner in the U.S ordered wheat from Europe,at $80 a tonne.The shipping time taken to get the wheat would be one month.However,he sold the goods on arrival in was $70,he will lose.To get over this uncertainity,he entered in to a derivative contract with a local dealer.He agreed to sell the good to him at a firm price $80 after one month.This is a typical forward contract and can be used for hedging.That is,insurance against uncertainity in prices.