FINANCIAL AND EXCHANGE RATE RISKS

Financial and Exchange Rate Risks Faced by Lufthansa and BMW

Financial and Exchange Rate Risks faced by Lufthansa and BMW

Introduction

After the collapse of the system of fixed exchange rates in 1973, foreign companies have started to learn to manage financial risks. In the past 30 years, a large number of methods are developed for managing financial risks such as exchange rate risk. For corporations that have operations around the world, like BMW and Lufthansa, poor risk assessment and management could lead to great losses. Risk management is one of the duties of financial managers, and foreign exchange hedging is an important factor in the strategic competitiveness of corporations (Bauwens 2006, 18). British enterprises are increasingly vulnerable to the influence of exchange rate changes and this applies not only to importers but exporters as well. Having a firm understanding of exchange rate and currency risk could help compete with foreign firms. The article examines the main categories of financial and exchange rate risk for non-financial corporations, as well as how companies like Lufthansa airlines and BMW respond to these risks by aligning their financial and marketing strategies to the other pertinent currency.

Exchange rate risk

Exchange rate risk is the uncertainty of the value of a currency that occurs when one currency is converted into another. This source of risk applies only if the investor acquires foreign assets denominated in a foreign currency. Avoiding such assets means the investor avoids this source of risk. (Philippe 2003, 18)However, because the individual may acquire shares in domestic firms with foreign operations or shares in mutual funds that make foreign investments, the individual still may indirectly bear exchange rate risk. If the investor bears more risk, he or she may earn a higher return. This is the essential trade off that all investors must face. Federally insured savings accounts offer lower yields but are less risky than bonds issued by (ABC Company).

Essentially this risk emerges when some financial flows from the project are stated in a different currency. This often occurs in international projects where costs and revenues are computed in different currencies. However, a similar situation may arise in domestic projects when counterparty wants to bill the company in foreign currency. Various industrial multinational groups for example, customarily invoice in a hard currency, even if it is not that of the host country. (Peter 2003, 17) When possible, the best risk coverage strategy is currency matching. In other words, advisors of an SPV try to state as many flows as possible in the home currency, avoiding any use of foreign currency. If this is not possible (usually because counter parties have strong bargaining power) the following coverage instruments provided by financial intermediaries must he used:

Forward agreements for buying or selling

Futures on exchange rates

Options on exchange rates

Currency swaps

Most of the multination banks and corporations manager claims that predicting currency fluctuations is more difficult than predicting the stock market. (Maurice 2009, 25)The tendency of a firm to managing and control its currency ...