Foreign Exchange Risk

Foreign Exchange (FX) risk management is driven by the corporates FX objectives, policy and strategy and is enabled by the implementation of a good FX risk management process.

In order to implement a good FX risk management process companies can apply the Zanders corporate risk management framework starting with identification of different kind of FX exposures, as follows :

transaction exposure: the risk of value changes of a transaction executed in foreign currency measured in the functional currency as a result of foreign exchange fluctuations;
translation exposure: which arises when a company has subsidiaries with a functional currency other than the reporting currency of the holding. Translation exposures are often split into profit translation exposures and (net) asset translation exposures; and
economic exposure: is the future impact on cash flows and earnings of a company as a result of long-term changes in FX rates which impact competitiveness and other strategic factors of the company.

The FX objectives are defined to facilitate proper management of the impact of FX movements on the corporate business. Expected cash flows can deviate significantly when calculated according to the functional currency of the company over time due to FX volatility. The company’s decision on the level of acceptable risk needs to be embedded in the FX objectives. Leading objectives for corporates to manage their FX exposures: