Answers finance question



Answers finance question

Introduction

Foreign exchange (FX) is a risk factor that must be considered by all firms that wish to enter, grow, and succeed in the global marketplace. Although most U.S. exporters prefer to sell their goods in U.S. dollars, creditworthy foreign buyers are increasingly demanding to pay in their local currencies (“Foreign Exchange Risk Management”, n.d.). Therefore, this currency exchange adds risk to any global trade that must be accounted for and managed, for a firm to remain competitive in the global marketplace.

Volatile Nature of the FX Market

As stated earlier, the primary reasons for currency fluctuation, is economic or political instability. A perfect example was highlighted in an article by Sujata Roa (2012), about the currency woes that have befallen Egypt since the ouster of president Hosni Mubarak in early 2011. In his article, Roa (2012) suggested that because of the political upheaval, Egypt “will now hurtle towards a balance of payments crisis and currency collapse”.

This political unrest has directly contributed to the Egyptian economy flat-lining, which in turn has lead to investors and direct foreign investment leaving the country for greener pastures with less uncertainty. According to Roa (2012), the most recent data shows that the amount of direct foreign investment has plummeted to one tenth of what it was a year ago. The exodus of investment capital has depleted Egypt's currency reserves by half, down to just $6 billion in the last sixteen months (Roa, 2012). Egypt's credit rating has also been downgraded to B-plus, which makes borrowing to meet their obligation more expensive, if the arrangements can even be made in view of their political and economic shakiness.

FX Risk Exposure

The starting point for any foreign exchange risk management plan formulation, is to identify the risk exposure faced.

Transaction exposure: These are considered transactions that touch ...