Financial and Operational Hedging of Exposure to Foreign Exchange Risk

Abstract

Management of exposure to foreign exchange risk centres on the concept of hedging, which is a process whereby a firm can be protected from unanticipated changes in exchange rates. As business becomes global, firms get increasingly engaged in international activities such as exports, cross-border sourcing, joint venture with foreign partners, and establishing production and sales affiliates abroad. As a result, firms find it necessary to pay careful attention to the exposure to foreign exchange risk and to the design and implementation of appropriate hedging strategies. This is because changes in exchange rates affect the values of cash flows (costs and revenues), assets, liabilities, market share and the competitive position of the firm.