Currency risk can be termed a sudden fall in the value of a particular currency. This happens due to unexpected shifts in the currency exchange rates. To avoid or minimize losses caused by these incidents, proper currency risk management strategy is very essential.
Currency risks are related to the floating exchange rates. The currency exchanges are done for a number of reasons. Nowadays, cross border commercial activities are growing at a rapid pace. Almost everything starting from goods to technologies are exchanged between the traders of different countries.
These transactions are subjected to currency risk because floating exchange rates are minimizing the chances of fixing the value of a particular currency. On the other hand, there are the forex market traders who are involved in trading of currencies of different countries.
These traders participate in the activities of one of the most liquid world financial markets.A large number of banks, individuals as well as several national governments are involved in these activities. These institutions as well as the individual investors are also in need of currency risk management because the forex market rates and trends change very quickly.
Two types of risks are managed by currency risk management strategies. These are the systematic risk and unsystematic risk. Systematic risks are all those risks that affect each and every kind of investments. Interest rate risk, market risk as well as inflation risk, all are considered as systematic risks. On the other hand, there are the unsystematic risks like business and financial risk. Unsystematic risk affects some definite businesses and not the entire market.
One of the most common currency risk management tool is the forward exchange contract. According to these contracts that are signed between the potential seller and purchaser of a particular currency, the exchange rates are fixed before the actual transaction. The transaction takes place in the future but due to the contract, if the exchange rate of that currency changes at the time of transaction, the purchaser and the seller are not affected.
There should also be a definite trading strategy that can be very helpful in hedging the currency risks. These strategies should be developed after analyzing the market averages or market indexes properly. On the other hand, there are certain theories regarding the trading process in the currency market. These are also very helpful for currency risk management. All these are specialized things and one may seek professional assistance from the currency risk management firms for the purpose.
Last Updated on : 8th July 2013