Sample Essay Paper on Foreign Exchange Risk Management

Foreign Exchange Risk Management

The foreign exchange market has associated risks that pose significant challenges to business transactions. Relevant to this study is the risk of currency fluctuations and changes in the cost of business transactions across international markets. Foreign exchange risk management remains relevant to company operations, which can either take the form of risk avoidance, risk transfer to another party, or accepting and adapting to risks. International deal makers, however, choose to avoid all the risks associated with currency fluctuations by advocating to be paid in their local currencies, especially when the exchange rates for a foreign currency are higher. One important characteristic to note in this case is that while international dealers try to avoid foreign risks, one transacting entity remains vulnerable since the entity will bear all the costs associated with the mentioned foreign currency risks.

Allocating foreign exchange risks to another party becomes the best option for international dealers and businesses operating on a global scale. This since the major objective of foreign market participants is to increase foreign earnings and maintain effective standards of operation. A rise in foreign exchange rates, for example the US dollar becoming stronger than the Japanese yen, has an impact on any transaction negotiations between an American Company and a Japanese adhesive manufacturer, and while the American Company benefits from such business transactions, the Japanese manufacturer will suffer losses if paid in foreign currency. For a fair deal to exist between the two companies, the Japanese manufacturer may demand all the payments to be made in the Yen, in order to reduce financial losses. With such response, the American Company incurs much cost purchasing items from the Japanese manufacturers. This cost will have been transferred to the American company, and instead of affecting the Japanese manufacturer, the terms of transaction in this case would affect the American Company.