I. Introduction
Globalization has been considered as the main culprit in the current situation of international trading nowadays. To those who have faith and accept the rationale of globalization, the observable fact has accomplished a number of important contributions in shifting the situation of the world. Majority of experts possess the same opinion that it has developed communication, transportation, and information technologies internationally. (2000) With the exception of the above-mentioned advantages, it has similarly tendered benefits in trade. Similarly, periods of intensifying international trade have commonly been times of financial development. However, there are still risks in exposure in the international market. In this context, this study will look into the management of those risks. Specifically, the study will take into account the foreign exchange risk management techniques that are used in the United States. In the same manner, to closely delve into the matter, the said risk will also be discussed so as to effectively provide recommendations at the end of the paper.
II. Management of Foreign Exchange Risk
Before discussing the main management of the risks posed by foreign exchange exposure, a close discussion on the actual risk is in order. According to (1996) there are three types of foreign exchange risks. These risks include structural risk, transaction risk, and portfolio risks. A structural risk represents a variance in the inflow and outflow of cash based on the currency difference which may well be caused by fluctuations in the foreign exchange rate. On the other hand, a transactions risk results from the time lags present in any international transaction. Specifically, the risks involve when the parties commit to pay and when it actually makes the necessary imbursement in the transaction. The third represents the issue when a specific company operates using different currencies. This is actually possible in multinational companies that operate in different parts of the globe. To illustrate, companies with US based headquarters will have a risk involving the profit and cash flows of their companies that operate in another country which uses a currency different from the dollar amount. This means that there is the possibility that a higher or lower operating profit may ensue when it is converted to the parent currency, in this case US dollars.
III. Foreign Exchange Risk Management
There are specific strategies that are taken by US multinational firms to manage the risk of foreign exchange. One of them is pricing. This means that companies could control the risk by imposing a billing currency. They could similarly do this by billing their customers with the same currency that the company uses in its operations. ( 2003) Another strategy is settlement. This is used when a company is not able to use its parent currency. The objective is to continuously negotiate early payments from the other company so as to remove any risk provided by the changes in foreign exchange. ( 2002) Forward contracts could also be used as an alternative strategy to mitigate the risk involved in foreign exchange. This strategy is taken when the previous two is not viable. ( 2001) Specifically, the said strategy is to impose a contract to purchase or sell foreign currency any time at the future given a fixed exchange rate. This is a hedging technique that allows companies to accommodate risk-averse counterparts into forming contractual relationship with them. Another common technique is netting. This technique is applicable to a group of related companies. This technique requires a reduction of foreign exchange conversion fees and fund transfer fees and a much shorter span of settlement in terms of the payables among those involved. (2000)
IV. Conclusion
Apparently, the existence of free trade and exposure to foreign exchange provides an advantage to everyone considering the open access to goods and services that is able to grant states with the most favorable opportunities for development. However, in a more realistic sense, the emergence of globalization favors predominantly the wealthy nations. It is possible that these countries, given their influence in the international community, are able to manipulate to their advantage the rules regarding trade. (2000) In this context, the economic institutions of the international community are thus being possibly controlled by the powerful nations especially when the subject of foreign exchange is taken into consideration. Companies from less powerful and influential countries are subject to the said risks. And based on the discussions above, there are indeed several courses of action that could be taken to avoid these. The effectiveness and applicability of the said courses of action to nations other than the United States have yet to present itself, thus, it is the contention of this paper to recommend further study on the said matter.
V. Recommendation
Based on the discussions above, it appears that the risk among the players in the industry is highest at the settlement of the accounts between companies. This study intends to provide a couple of recommendations to minimize the said risk.
A. Take away any form of delay
In this suggestion, a considerable amount of changes will be needed in the way international payments are carried out. One major change is the requirement to close down the gaps in the hours of operations of payment systems in countries. This means that some sort of standardization of the payment systems across countries is needed in order to provide a uniform means of payment especially when a particular kind of currency is involved. Similarly, this course of action needs a verification system that will ensure the permanent nature of the payments made and the possibility for the parties involved to make use of the said monetary provisions once they are acquired from their counterpart. This means that specific policy changes in the central banks of every state would possibly be in order.
B. Reduction of size
The need of a solid clearing bank that will cater to every nation is conceived to be the answer for any risk in foreign exchange transactions. Though there is still yet any indication on whether such a well build clearing bank does exist, netting arrangements are taken as a viable substitute. It in this situation that contracts among parties are taken into a clearinghouse arrangement and enables the parties to be secure in their settlement arrangements particularly with respect to the currencies used in the transactions. In this manner, the risk is significantly reduced by reducing the size of the transactions among the parties.
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