money-drained

MANAGING CURRENCY RISK

July 6th, 2009

Transactional currency risk can be hedged tactically or strategically by the corporate Treasury to preserve cash flow and earnings, depending on their currency view.
Translational currency risk is usually hedged opportunistically rather than systematically, notably to try to avoid emerging market-related shocks to net assets, usually focusing on either long-term foreign investment or debt structure.
Hedging economic risk is complex, requiring the corporation to forecast its revenue and cost streams over a given period and then to analyse the potential impact on these of an exchange rate deviation from the rate used in calculating revenue and cost. For the debt structure, the currency of denomination must be chosen, the amount of debt estimated in that currency and the average interest period determined. The effect on cash flow should be netted out over product lines and across markets. What’s left from this process is the economic risk that has to be managed. For large multinationals, the net economic risk may in fact be quite small because of offsetting effects. However, economic risk can be substantial for corporations that have invested in only one or two foreign markets.
The first two steps of this process appear to have been accomplished. Firstly, we have defined very specifically the types of currency risk that a corporation is exposed to. Secondly, we have looked at broad strategy, the brushstrokes of managing that currency risk. Yet, while this currency risk may be defined, it must also be quantified. Quantifying an amount of currency may be easy for transaction risk, but for translation or economic risk it is no easy task. Just as with other types of risk management, the most popular way of doing this is to use a “VaR” model.

Filed under: Risk

Tags: Cash, Currency, Risk