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Chapter 13

Foreign currency risk

Foreign currency risk arises for companies that trade internationally.

1.1 Exchange rate systems

In a floating exchange rate system:

 the authorities allow the forces of supply and demand to continuously change
the exchange rates without intervention

Increased demand for a currency or a shortage of supply would cause its price (rate)
to rise and vice versa.

 the future value of a currency against other currencies is uncertain

 the value of foreign trades will be affected

The world’s leading currencies such as the US dollar, Japanese Yen, British pound
and the European Euro float against each other.

Other systems include:

 fixed exchange rates (where a government uses monetary policy and other
methods to hold the rate steady)

 freely floating exchange rates (no intervention by governments)

 managed floating exchange rates (intervention to keep the value within a range)

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