Introduction to Finance

Currency exchange rate risk
 
is the price risk associated with fl uctuating exchange rates over 
time. For example, a business transaction (involving, say, the purchase of goods from a foreign 
currency exchange rate risk 
the 
price risk associated with fl uctuating
exchange rates over time
(Index, March 1973 = 100)
60
70
80
100
110
130
140
90
120
150
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2012
2010
2008
2014
2016
FIGURE 6.2
U.S. Dollar Value Relative to an Index of Major Currencies

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C H A PT E R 6 International Finance and Trade
manufacturer) conducted at today’s U.S. dollar to euro exchange rate with payment being due 
immediately would not be subjected to a currency exchange rate risk. However, when the date 
of the transaction precedes the payment date, the $US to euro exchange rate relationship could 
change, causing the fi nal results of the transaction to be more costly (or less costly).
While mutinational corporations, as well as individuals and institutional investors, may 
engage in foreign exchange speculation as opportunities arise, risk reduction is their primary 
goal. Among the possible actions of foreign exchange specialists are hedging, adjusting 
accounts receivable and payable procedures, cash management, and borrowing and lending 
activities. Existing or anticipated variations in the value of foreign currencies guide all these 
actions. 
Hedging
 
is an action taken to reduce risk or insure against a possible negative outcome. 
A multinational corporation may want to lock in an exchange rate at which a currency can be 
obtained at in the future. For example, a multinational corporation with a claim for payment 
within 90 days may anticipate a possible decline in the currency value of the customer’s 
country. The seller can hedge by entering into a fi nancial contract for the delivery of that cur-
rency at the existing exchange rate on the day of the contract. To accomplish the hedge, the 
multinational corporation might enter into a