Free Online Course in International BusinessTask 2After evaluating foreign currency exchange risk, select, implement, and manage risk mitigation techniques to protect the company against fluctuation of foreign exchange.IntroductionThe globalization of business generates foreign currency risks which need to be recognized. The globalization process is irreversible and will be critical to the survival of most industries and businesses. This process affords enormous opportunities to diversify business risk, generate economies of scale and capture additional market share. Managing foreign exchange risk requires understanding political, economic and financial markets. It is not always possible for all participants to have experience in the market options available. It is possible to have sufficient knowledge to mitigate most of the risks that businesses can face. Managing foreign exchange risk requires understanding currency convertibility with open or closed borders when exchange rates are fixed, floating or managed. Knowing the appropriate hedging actions to take is essential in any of these complex situations.A success global business professional may not actively participate in foreign exchange risk mitigation; however, understanding the risks and opportunities is essential to operating a profitable international business. To master the concepts in this Task, you must know and understand foreign exchange risk mitigation techniques and required documentation: hedging tools, currency option contracts, and transfer pricing. Knowledge StatementKnowledge of Foreign Exchange Risk Mitigation Techniques and Required Documentation: Hedging Tools, Currency Option Contracts, Transfer Pricing Goal.The goal of this material is to introduce you to mitigation techniques and their required documentation related to foreign exchange (FX) risk. Learning ObjectivesYou will be able to• identify foreign currency risk. • identify the different instruments available in the FX market to hedge FX risk. • identify the features of a FX spot transaction and the documentation required for a spot transaction. • describe transfer pricing and its use as a FX risk mitigation tool. IntroductionThe globalization of business generates foreign currency risks. This process is irreversible and critical to the survival of most industries and businesses. The "globalization process" affords enormous opportunities to diversify business risk, generate economies of scale and capture additional market share.Companies can no longer state "Our company deals only in US dollars" since this approach is not sustainable in global trade. It is estimated that 40% of all international trade is denominated in foreign currency. Trillions per day move through the foreign exchange markets. Political factors determine that not all currencies are convertible. Commercial trade is full of challenges, many of which may be overcome by utilizing the options available in this section. Types of Rates of Exchange• Fixed rate of exchange - A fixed rate of exchange is a ratio established by the government at which foreign currencies can be exchanged. The value of the national currency is based on parity with other currencies. Sustaining the parity is the question: if other factors force a market change to a floating rate, the impact could negatively impact the country. • Floating rate of exchange - A floating rate of exchange allows open market conditions to determine the value of the currency in relationship to other currencies. Open market exchange rates are highly volatile and change every 5 seconds or 18,000 times per day. Any given currency typically fluctuates 1% during a 24 hour period. The volatility of the market is influenced by political, economic and technical conditions that come into play and cause fluctuations that may exceed the typical movement. This volatility translates into the need to manage the risk of rising or falling exchange rates. • Managed rate of exchange - A managed rate of exchange allows a central bank to intervene to adjust for market conditions. It controls wide valuation swings that may occur due to adverse market conditions.
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