5.4 Foreign exchange risk management
Currency risk or (as it is often called)foreign exchange risk refers to fluctuations in the domestic currency value of assets, liabilities, income or expenditure due to unanticipated changes in exchange rates.Many techniques are available to cover or hedge exposure to risk of this kind.The simplest and most common technique involves using a forward contract.Remember that the forward market is where currencies are traded for future delivery and that the forward exchange rate is the current price of one currency for another for delivery at a specified date in the future.In the first part of this section we will see how a forward contract can be employed to hedge foreign exchange risk.We will then apply these principles to currency futures.Finally, we will look at some of the most common hedging instruments available to the corporate treasurer.They include the over-the-counter forward market, the Eurocurrency market and swaps.