Corporate
risk management is a practice to optimize the risks in business operations
and investing. The business leaders are responsible to control and management
the risk to strengthen the business and maximise the shareholders wealth.
A business
firm can have various types of risk, however, a firm which has international
business have almost all the time there is a risk of foreign currency exchange
risk. Unexpected exchange rate would change the value of the company. It could
either be a gain or loss to the firm as well as to the shareholder.
Identifying
potential sources of trouble, analysing them and taking necessary steps to
prevent the loss are a duty of a business leader. Do all the business leaders fulfil
this duty? My view is only the leaders with sound financial knowledge and experiences
are capable to follow due to the complexity of international finance and the
risk involved.
In
order to measure the impact of exchange rate movement of a firm, it is important
to understand the type of the risk the firm is facing at present. A firm could
face three types of risks namely, transaction risk, translation risk and
economic risk.
Currency
market is volatile. When the market is fluctuant, income derived from foreign
operations/transactions could be affected. Similarly, a risk in translating
company assets and liabilities in terms of home currency and foreign currency,
therefore, the misinterpretation of the company could result the loss of
potential investor and it could affect to the shareholders too. Unlike the
transaction and translation risk, the economic risk is related to the currency determination.
It is basically the risk to the firm’s present value of future operating cash
flows from exchange rate movement. For example, oil prices are set in USD, if
the USD strengthens against the Euro, the oil company should increase the
price.
Being a
fluctuation of foreign currency could cause a risk to business profitability, a
business leader must prevent the loss to the shareholders and organisation,
however, risks vary from a business to business, depending on the size,
industry, diversity of business lines, source of capital, the practices to
tackle the situation are differed.
To
reduce or eradicate the risk, many business organizations consider the hedging
as a tool. It could be done in number of ways such as offsetting the borrowing
or lending at market rate or purchasing a forwarding exchange contract to a
future date, hedging foreign currency options or position the funds through
transfer pricing and etc. They all effectively serve the same purpose but
slightly in different ways.
The
recent various news are indicating the change of Japanese Yen and Latin America
currency has affected the many business operations such as LG, Samsung and etc.
As
per FiREapps 2013Q3 Corporate Earnings Currency Impact Report, the most top 5
industries were Medical equiptment & supplies, Auto, Chemical Manufacturig, Biotech & Drugs and Services
Business.
This
evidence the impact of foreign currency exchange risk to an organisation,
therefore, business leader should not ignore and identify the possible way to
handle the situation. Otherwise, the business
could lead into failure and would have a severe affect to the shareholder
wealth.
References:
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