Risk is inherent in a global marketplace.
Billions of dollars worth of goods and services are traded around the world every day. This global exchange provides customers with many choices and corporations with large opportunities, but there can also be great foreign exchange risk if the value of currencies rises or falls dramatically.
History
The pillars of the modern foreign exchange system were laid down in 1944 with the signing of the Breton Woods Agreement. The accord provided for a sophisticated medium of global currency exchange, laying the bedrock for the mechanisms later used to manage, control and exploit foreign exchange rate risk.
Significance
Foreign exchange rate risk is significant because more companies have exposure to foreign markets than ever before, meaning their profits are affected by the ever-changing values of an increasingly diverse array of currencies.
Types
Three major participants in the foreign exchange system are international companies looking to hedge against currency losses in foreign markets, global banks that make markets in currencies and currency speculators hoping to profit from fluctuating prices. Companies and banks typically have greater strategic risk, while speculators encounter more tactical risk on each trade.
Geography
Foreign exchange risk affects almost every country in the world, from large export powerhouses such as Japan, China and Germany to emerging-market countries such as India, Brazil and Russia.
Size
The magnitude of foreign exchange risk varies from country to country and corporation to corporation. The more foreign trade a nation or company depends on, the larger its foreign exchange risk is.
Example
A Japanese electronics manufacturer with considerable export business to the United States would want the yen to trade at low levels against the dollar, because this allows it to produce its products cheaply, with expenses denominated in yen, and earn its revenue in the more valuable dollar. The company faces the possibility of large losses if the yen appreciates significantly against the dollar, because its input costs will be higher and its revenues will be lower.
