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Exchange Rate Risk Measurement and Management

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  • Michael G. Papaioannou
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    Abstract

    Measuring and managing exchange rate risk exposure is important for reducing a firm''s vulnerabilities from major exchange rate movements, which could adversely affect profit margins and the value of assets. This paper reviews the traditional types of exchange rate risk faced by firms, namely transaction, translation and economic risks, presents the VaR approach as the currently predominant method of measuring a firm''s exchange rate risk exposure, and examines the main advantages and disadvantages of various exchange rate risk management strategies, including tactical versus strategical and passive versus active hedging. In addition, it outlines a set of widely accepted best practices in managing currency risk and presents some of the main hedging instruments in the OTC and exchange-traded markets. The paper also provides some data on the use of financial derivatives instruments, and hedging practices by U.S. firms.

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    Bibliographic Info

    Paper provided by International Monetary Fund in its series IMF Working Papers with number 06/255.

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    Length: 20
    Date of creation: 01 Nov 2006
    Date of revision:
    Handle: RePEc:imf:imfwpa:06/255

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    Related research

    Keywords: Financial risk; Financial management; Risk management; Exchange rates; Industry; Economic models; hedging; exchange rate; currency risk; foreign exchange; exchange rate risk; hedge; hedging instruments; currency hedging; derivative; cash flows; hedging strategies; cash flow; currency futures; derivatives instruments; exchange rate changes; exchange rate movements; derivative instruments; foreign exchange derivatives; hedging instrument; futures contract; average exchange rate; interest rate risk; international finance; hedges; currency swaps; exchange risk; present value; future cash flows; foreign exchange rate; currency hedging instruments; futures contracts; futures markets; financial instruments; derivative financial instruments; currency risks; financial statements; spot exchange rate; foreign exchange risk; currency units; forward market; derivatives markets; financial derivatives instruments; net cash flows; currency derivatives; stock market; derivatives market; unhedged position; cash flow risk; exchange rate risks; exchange rate level; international financial markets; operating cash flows; currency markets; bilateral exchange rates; effect of exchange rate changes; exchange rate exposure; hedge accounting; foreign exchange derivative; cash flow hedging; currency crises; exchange rate forecasting; financial markets; currency of denomination; future cash flow; exchange rate adjustments; foreign exchange contracts; exchange rate change; current exchange rate;

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    1. Gordon M. Bodnar & Gunther Gebhardt, 1998. "Derivatives Usage in Risk Management by US and German Non-Financial Firms: A Comparative Survey," NBER Working Papers 6705, National Bureau of Economic Research, Inc.
    2. Bansal, Ravi & Dahlquist, Magnus, 2000. "The forward premium puzzle: different tales from developed and emerging economies," Journal of International Economics, Elsevier, vol. 51(1), pages 115-144, June.
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    Cited by:
    1. Vít Bubák & Filip Žikeš, 2009. "Distribution and Dynamics of Central-European Exchange Rates: Evidence from Intraday Data," Czech Journal of Economics and Finance (Finance a uver), Charles University Prague, Faculty of Social Sciences, vol. 59(4), pages 334-359, Oktober.
    2. Jimmy Melo, 2014. "Expectativas cambiarias, selección adversa y liquidez," Ensayos Revista de Economia, Universidad Autonoma de Nuevo Leon, Facultad de Economia, vol. 0(1), pages 27-62, May.

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