A PROJECT REPORT ON

BANKING PERIOD DURING PRE AND POST PERIOD

SUBMITTED

TO THE UNIVERSITY OF MUMBAI

AS A PARTIAL REQUIREMENT FOR COMPLETING POST GRADUATION OF

M.COM (BANKING AND FINANCE) SEMESTER 2

SUBMITTED BY:

UNDER THE GUIDANCE OF

1

SIES COLLEGE OF COMMERCE AND ECONOMICS,

PLOT NO. 71/72, SION MATUNGA ESTATE

T.V. CHIDAMBARAM MARG,

SION (EAST), MUMBAI – 400022.

CERTIFICATE

This is to certify that Miss of M.Com (Banking and Finance) Semester II (academic year

2014-2015) has successfully completed the project onFOREIGN EXCHANGE RISK AND COVERAGE under the

Guidance of Mrs Neelima Diwakar

_________________ ___________________ (Project Guide) (Course Co-ordinator)

___________________ ___________________ (External Examiner) (Principal)

Place: _____________ Date: ___________

DECLARATION

2

I Student M.Com (Banking and Finance) Semester II (academic year

2013-2014) hereby declare that, I have completed the project on FOREIGN EXCHANGE RISK AND COVERAGE.

The information presented in this project is true and original to the best of my knowledge.

Place: _____________Date:_____________

3

___________________Name:

Roll No.:

ACKNOWLEDGEMENT

I would like to thank the University of Mumbai, for introducing M.Com (Banking and Finance) course, thereby giving its students a platform to be abreast with changing business scenario, with the help of theory as a base and practical as a solution.

I am indebted to the reviewer of the project Dr. Minu Thomas my project guide who is also our principal, for her support and guidance. I would sincerely like to thank her for all her efforts.

Last but not the least; I would like to thank my parents for giving the best education and for their support and contribution without which this project would not have been possible.

______________________

Name :SONAM JAIN Roll no:46

4

SR NO. CONTENT PG NO.

1. MEANING 6

2. Foreign Exchange Risk 10

3. Types Of Exposure 13

4. Risk Coverage 19

5. CONCLUSION 23

6. BIBLOGRAPHY 25

5

MEANINGForeign exchange trading is essentially the trading of the currency from two

countries against each other. The pairs are predetermined by brokers, who may or

may not offer a match for the currency pair that you want to trade.For example,

a popular pair that is widely traded is the EUR/USD. The EUR/USD is the

European Dollar, also known as the EURO, and the USD, which is the US Dollar.

When the Euro becomes worth more money in dollars, the pair goes up, when it

becomes worth less money in dollars, the pair drops in value.

If you were to speculate that the USD was going to drop in value compared to the

Euro, you would buy the EUR/USD and wait for it to start rising. This is called

going long. If you thought the

Dollar would gain in value compared to the Euro, you would go short on the

EUR/USD pair. All of this trading is done through forex brokers. A forex

brokerage is an intermediary that takes on your trade and puts it on theopen

market. Foreign exchange trading is not done through any centralized market, so

all forex broker rates may not be exactly the same at the same time. Forex brokers

deal with networks of banks and the trading is carried out electronically within

fractions of a second when orders are placed.

The whole purpose of trading forex online, for most people, is to make money.

Corporations sometimes use it to offset a contract or future purchase that they plan

to make.

One thing that really adds to the fun is that forex brokers offer forex leverage to

help you in your trading. Trading with leverage is basically the forex

broker allowing you to trade more on the market than what you actually have in

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your account. This is an advantage for them because they collect fees based on the

size of the trades that you make. The larger the trade, the larger the fee. Every time

you make a trade with a forex broker they collect what they call the spread, which

is a tiny piece of your trade.

Trading with leverage seems like it would be a really great advantage, and it can

be, but it can hurt you just as much as it can help you. Many new traders start out

using as much leverage as possible and that typically leads to quick losses and an

account blow up. This is a good reason for new traders to take them time learning

to trade forex and start out using as little leverage as possible when trading.

When it comes down to it, trading is simple. You look for

currencies that will appreciate versus other currencies. Wait for a good time to buy,

and then be patient. This simple forex trading system can make you into a forex

winner with ease, but it's harder to achieve than you might think. Most people

jump into forex trading with the expectation that it's an easy way to get rich. This

causes them to make mistakes because of their expectations, and fail. Once they've

failed, you'll hear various excuses such as the market is rigged and fraudulent. The

truth is that stocks and other markets are traded in very similar ways, the difference

is theeffect of using leverage. Forex trading is a good way to make money, but it's

just like other forms of investment. It takes some education and patience. If you

keep your head together, you can make some money.

Forex is a hybrid word that represents Foreign Exchange. It's most commonly used

to describe foreign exchange trading.

Forex is changing one currency for another. In forex trading, the pairs are preset

pairs that are paired up by brokers that allow account holders to make exchanges.

The object of making the exchange is to hold the exchange until the value increase

and then exchange the currency back.

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This will sound more complicated in explanation than it actually is in

process. Forex brokers offer currency pairs, such asEUR/USD, which is European

Dollar vs. the US Dollar. If you were to "go long" on this pair, you would be

buying Euros specifically against the US Dollar. If the Euro increased in value

against the US Dollar, you make a profit. You have to close or end your trade in

order to lock in your profit.

By "going short" on the same pair, you could trade it in reverse. That is, you would

make money if the Euro decreased in value against the US Dollar. This one of the

things about forex that is great, you can trade in either direction with no real

restrictions. The only thing is that you can only trade one way on acurrency pair at

a time, per account. However, there is no rule saying you can have only one

account, so really, you can trade the way that you want.

This sounds pretty simple and straight forward, however, there are some things that

make this a bit more of an adventure than it sounds.

Forex brokers offer leverage to forex traders so they can make trades that are larger

than their balance. Leverage can range from 200:1 to 50:1 on average. In the U.S.,

brokers are limited to offering 50:1. What this means, is that for every $1 you

deposit into your account, you can trade $50 on the foreign exchange market. In

forex, you typically trade withminimum lot sizes depending on your forex account

type.

This is all forex is in a nutshell. You can open an account with a forex broker, fund

it, and trade. It's that simple. At least, mechanically, it's that simple, there's more to

know. One thing that trading with leverage introduces is fear and greed. What I

mean by this is leverage enables you to trade for large gains in comparison with

your actual balance. It's possible to make some fast money putting big trades on the

8

market. Sometimes, it even seems like you can't lose. This works fine while you're

winning, this is the greed side.

The other side of this coin is the fear side. Often, traders without a

plan are the ones that feel the fear. You know that this is happening to you if you

feel very anxious while putting on a trade, and you tend to close your trades after

they've earned only a tiny bit. This tends to happen after a large loss, or even

starting over.

This emotional side to trading forex is what causes so many

people to lose their money and quit trading. To avoid becoming part of that

statistic, you need to practice, plan, keep a forex journal, and don't get carried

away. It seems more simple than it actually is. Many traders will blame their

failures on broker games, stop hunting, and other conspiracy theories. The truth is

that your trading success falls on your shoulders. If you find a decent broker, and

trade with care, you will survive, and if you are really careful, you might actually

make some money. Just avoid approaching it like a game and take it seriously. It

seems very easy to make money making clicks on a screen, but it still takes

planning and some strategy.

 Exchange rates allow you to determine how much of one

currency you can exchange for another. For example, the dollar's exchange

rate tells you how much a dollar is worth in a foreign currency, and vice versa.

You will definitely need to understand exchange rates when you travel to another

country. For example, if you traveled to Canada on September 30, 2013, you'd find

a dollar was worth

 

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Foreign exchange risk Foreign exchange risk  (also known as FX risk, exchange rate

risk or currency risk) is a financial risk that exists when a financial transaction is

denominated in a currency other than that of the base currency of the company.

Foreign exchange risk also exists when the foreign subsidiary of a firm maintains

financial statements in a currency other than the reporting currency of the

consolidated entity. The risk is that there may be an adverse movement in

the exchange rate of the denomination currency in relation to the base currency

before the date when the transaction is completed.[1][2] Investors and businesses

exporting or importing goods and services or making foreign investments have an

exchange rate risk which can have severe financial consequences; but steps can be

taken to manage (i.e., reduce) the risk.

Many businesses were unconcerned with and did not manage foreign exchange risk

under the Bretton Woods system of international monetary order. It wasn't until the

switch to floating exchange rates following the collapse of the Bretton Woods

system that firms became exposed to an increasing risk from exchange rate

fluctuations and began trading an increasing volume of financial derivatives in an

effort to hedge their exposure.[8][9] The currency crises of the 1990s and early

2000s, such as the Mexican peso crisis, Asian currency crisis, 1998 Russian

financial crisis, and the Argentine peso crisis, led to substantial losses from foreign

exchange and led firms to pay closer attention to their foreign exchange risk.

The risk of an investment's value changing due to changes in currency exchange

rates. The risk that an investor will have to close out a long or short position in a

foreign currency at a loss due to an adverse movement in exchange rates.Also

known as "currency risk" or "exchange-rate risk".

10

This risk usually affects businesses that export and/or import, but it can also affect

investors making international investments. For example, if money must be

converted to another currency to make a certain investment, then any changes in

the currency exchange rate will cause that investment's value to either decrease or

increase when the investment is sold and converted back into the original currency.

For Canadian companies that sell their goods and services internationally and get

paid in a foreign currency, foreign exchange risk is the likelihood that a change in

exchange rates will result in the company receiving a lower amount of Canadian

dollars than originally anticipated. For Canadian companies that import and pay

foreign suppliers in foreign currency, it is the likelihood that a change in exchange

rates will mean the company has to pay more than planned.

This form of foreign exchange exposure, which impacts the cash flow of the

company, is commonly referred to as transaction exposure.

When exports are invoiced in domestic currency, the (short-

term) exchange rate risk is borne by the importer rather than by the exporter. This

paper draws on the literature to consider under which conditions such a shifting of

the risk is possible and optimal for the exporting firm and then assesses the actual

use of euro invoicing by euro-area exporters, based on data collected by the ECB.

Exchange rate risk can also be neutralised ("hedged") through financial

instruments, such as exchange rate derivatives or foreign currency debt (financial

hedges), as well as through the operational setup of the exporting firm (operational

hedges). Financial derivatives have today become standard tools for hedging risks

related to exchange rates, interest rates or commodities prices. This paper discusses

hedging instruments and hedge design and surveys the literature on the use of

hedging. For the US, the use of hedging strategies and instruments is empirically

well documented. Other studies have covered firms in individual European

11

countries, but to the author's knowledge, none has so far taken a euro-area

perspective. This paper contributes to closing that gap through a survey of self-

reported hedging strategies and instruments of euro-area blue chip companies.

It is clear that importing firms also face exchange rate risk.

Transaction risk arises from foreign-currency denominated imports in the same

way as from foreign-currency denominated exports. The economic risk to which an

importing firm is subject concerns the variation of its costs induced by exchange

rate fluctuations. As in practice most multinational firms are at the same time

importers and exporters, their exposure to exchange rate risk is limited to net cash

flows in a particular currency. Finally, translation risk arises from the holding of

foreign assets irrespective of the net direction of trade flows. A gauge of the actual

relevance of exchange rate risk for firms can be found in the literature. Muller and

Verschoor (2006) use a sample of 817 multinational firms that are exchange-listed

and have their headquarters in the euro area to estimate their exposure to exchange

rate variations. They follow a widespread empirical approach by estimating the

impact of exchange rate variations on the firm's stock market returns, controlling

for the returns of the entire market. Over the entire period 1988-2002, 22% of

firms had significant exposure4 to the GBP exchange rate, 14% to the USD and

13% to the JPY.

12

Types of ExposureTransaction exposure

A firm has transaction exposure whenever it has contractual cash flows

(receivables and payables) whose values are subject to unanticipated changes in

exchange rates due to a contract being denominated in a foreign currency. To

realize the domestic value of its foreign-denominated cash flows, the firm must

exchange foreign currency for domestic currency. As firms negotiate contracts

with set prices and delivery dates in the face of a volatile foreign exchange market

with exchange rates constantly fluctuating, the firms face a risk of changes in the

exchange rate between the foreign and domestic currency. It refers to the risk

associated with the change in the exchange rate between the time an enterprise

initiates a transaction and settles it.

Applying public accounting rules causes firms with transactional exposures to be

impacted by a process known as "remeasurement". The current value of contractual

cash flows areremeasured at each balance sheet date. If the value of the currency of

payment or receivable changes in relation to the firm's base or reporting currency

from one balance sheet date to the next, the expected value of these cash flows will

change. U.S. accounting rules for this process are specified in ASC 830, originally

known as FAS 52. Under ASC 830, changes in the value of these contractual cash

flows due to currency valuation changes will impact current income.

Economic exposure

A firm has economic exposure (also known as forecast risk) to the degree that its

market value is influenced by unexpected exchange rate fluctuations. Such

exchange rate adjustments can severely affect the firm's market share position with

13

regards to its competitors, the firm's future cash flows, and ultimately the firm's

value. Economic exposure can affect the present value of future cash flows. Any

transaction that exposes the firm to foreign exchange risk also exposes the firm

economically, but economic exposure can be caused by other business activities

and investments which may not be mere international transactions, such as future

cash flows from fixed assets. A shift in exchange rates that influences the demand

for a good in some country would also be an economic exposure for a firm that

sells that good.

Translation exposure

A firm's translation exposure is the extent to which its financial reporting is

affected by exchange rate movements. As all firms generally must prepare

consolidated financial statements for reporting purposes, the consolidation process

for multinationals entails translating foreign assets and liabilities or the financial

statements of foreign subsidiary|subsidiaries from foreign to domestic

currency.While translation exposure may not affect a firm's cash flows, it could

have a significant impact on a firm's reported earnings and therefore its stock

price.Translation exposure is distinguished from transaction risk as a result of

income and losses from various types of risk having different accounting

treatments.

Contingent exposure

A firm has contingent exposure when bidding for foreign projects or negotiating

other contracts or foreign direct investments. Such an exposure arises from the

potential for a firm to suddenly face a transactional or economic foreign exchange

risk, contingent on the outcome of some contract or negotiation. For example, a

firm could be waiting for a project bid to be accepted by a foreign business or

government that if accepted would result in an immediate receivable. While

14

waiting, the firm faces a contingent exposure from the uncertainty as to whether or

not that receivable will happen. If the bid is accepted and a receivable is paid the

firm then faces a transaction exposure, so a firm may prefer to manage contingent

exposures.

Measurement

If foreign exchange markets are efficient such that purchasing power

parity, interest rate parity, and the international Fisher effect hold true, a firm or

investor needn't protect against foreign exchange risk due to an indifference toward

international investment decisions. A deviation from one or more of the three

international parity conditions generally needs to occur for an exposure to foreign

exchange risk.

Financial risk is most commonly measured in terms of the variance or standard

deviation of a variable such as percentage returns or rates of change. In foreign

exchange, a relevant factor would be the rate of change of the spot exchange rate

between currencies. Variance represents exchange rate risk by the spread of

exchange rates, whereas standard deviation represents exchange rate risk by the

amount exchange rates deviate, on average, from the mean exchange rate in

aprobability distribution. A higher standard deviation would signal a greater

currency risk. Economists have criticized the accuracy of standard deviation as a

risk indicator for its uniform treatment of deviations, be they positive or negative,

and for automatically squaring deviation values. Alternatives such as average

absolute deviation and semivariance have been advanced for measuring financial

risk.

Value at Risk

Practitioners have advanced and regulators have accepted a financial risk

management technique called value at risk (VaR), which examines the tail end of a

15

distribution of returns for changes in exchange rates to highlight the outcomes with

the worst returns. Banks in Europe have been authorized by the Bank for

International Settlements to employ VaR models of their own design in

establishing capital requirements for given levels of market risk. Using the VaR

model helps risk managers determine the amount that could be lost on an

investment portfolio over a certain period of time with a given probability of

changes in exchange rates. VaR typically is the risk measure of choice for FX

managers and risk departments because it expresses a portfolio’s risks in a

coherent and logical manner. It is expressed in real profit-andloss terms and can

directly tell a risk manager the potential risks inherent in a portfolio based on

varying degrees of statistical confidence. VaR traditionally is measured in the

following three ways: 1. historical simulation 2. variance/covariance (parametric)

3. Monte Carlo simulation Each method produces a statistical measurement of VaR

that is calculated using an historical data assumption to give a level of confidence

that is determined from the historical price action. Each method differs in

complexity and has advantages and disadvantages. Historical simulation assumes

that the past is a good predictor of the future and that the volatility of the analyzed

currencies will remain stable, within the parameters observed in the past. It uses

real historical data and therefore importantly does not assume that the returns are

normally distributed. It is, however, computationally intensive and completely

dependent on historical price movements, and therefore it can seriously

underestimate “tail risk.” (Tail risk is a measurement of the probability of an event

occurring at the extremes of a given distribution, the reasons for this will be

explained later in this article.) Historical simulation is also dependent on the

quality and depth of the input data, which can be problematic for emerging market

currencies. Variance/covariance, sometimes known as parametric VaR, is

computationally easier because historical data is used to calculate the standard

16

deviation of the changes of risk factors and the correlations between them. It is

heavily disadvantaged by an assumption of the linearity of risk (the assumption

that risk vs. reward is linear in nature, which is not the case with more-complex

financial instruments such as options), that correlations are stable over time, and

that returns are distributed normally. Products such as options introduce nonlinear

risk parameters, correlations can quickly and dramatically uncouple, and as we

have seen in.

Management

Firms with exposure to foreign exchange risk may use a number of foreign

exchange hedging strategies to reduce the exchange rate risk. Transaction exposure

can be reduced either with the use of the money markets, foreign exchange

derivatives such as forward contracts, futures contracts, options, and swaps, or with

operational techniques such as currency invoicing, leading and lagging of receipts

and payments, and exposure netting.

Firms may adopt alternative strategies to financial hedging for managing their

economic or operating exposure, by carefully selecting production sites with a

mind for lowering costs, using a policy of flexible sourcing in its supply chain

management, diversifying its export market across a greater number of countries,

or by implementing strong research and development activities and differentiating

its products in pursuit of greater inelasticity and less foreign exchange risk

exposure.

Translation exposure is largely dependent on the accounting standards of the home

country and the translation methods required by those standards. For example, the

United States Federal Accounting Standards Board specifies when and where to

use certain methods such as the temporal method and current rate method. Firms

can manage translation exposure by performing a balance sheet hedge. Since

17

translation exposure arises from discrepancies between net assets and net liabilities

on a balance sheet solely from exchange rate differences. Following this logic, a

firm could acquire an appropriate amount of exposed assets or liabilities to balance

any outstanding discrepancy. Foreign exchange derivatives may also be used to

hedge against translation exposure

Transaction risk refers to the impact of exchange rate changes on

the value of committed cash flows (cash flows that lie in the future, but the

nominal value of which is known). These are mostly receivables (payables) from

export (import) contracts and repatriation of dividends. Usually, the time frame for

committed transactions (the time between contracting and payment) is relatively

short. However, it can in some cases reach several years, where deliveries are

committed a long time in advance (e.g. US dollar-denominated forward sales of

planes or building contracts). Economic risk refers to the impact of exchange rate

movements on the present value of uncertain future cash flows. It comprises the

impact of exchange rate variation on future revenues and expenses through both

variations in price and volume. Translation risk refers to the impact of exchange

rate changes on the valuation of foreign assets (mainly foreign subsidiaries) and

liabilities on a multinational company's consolidated balance sheet. Usually,

translation risk is measured in net terms, i.e. net foreign assets minus net foreign

liabilities.

18

RISK COVERAGE

Whether dealing in U.S. dollars or in a foreign currency, every

international transaction has inherent risks such as country risk, risk of non

payment from foreign buyers, risk of non-delivery from foreign suppliers, and,

when a foreign currency is involved, foreign exchange risk. Santander Bank, N.A.

(“Santander”) is prepared to assist your company in mitigating these risks.

Country Risk

Country Risk is the risk of investing in a foreign country. It includes all

the risks that are specific for the country and that will affect the local companies’

transactions with foreign investors. It includes political risk, economic risk, or

transfer risk, which is the risk of the government or central bank not allowing

capital to move out of the country. There are insurance policies from the Export-

Import Bank of the United States Ex-Im Bank and some private insurers that can

protect an exporter against the occurrence of these events.

Payment and Delivery Risk

Payment risk is the risk of not getting paid or getting paid late by your

buyer. Delivery risk is the risk of your foreign supplier not being able to fulfill its

side of the sales agreement.

Ideally, your company would diminish these risks by selling under

cash in advance terms or buying on open account. However, when these are not

possible, you can also reduce the risks of non-payment and non-delivery of a

certain transaction by using a different payment method such as Documentary

Collections and Letters of Credit.

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Foreign Exchange Risk

Currency or Foreign Exchange (“FX”) risk occurs when a US

company buys or sells in a currency different than US dollars, and is generated by

the volatility of the price of one currency against the other. Santander Bank offers

you a wide range of FX products to mitigate currency risk for your international

transactions.

Spot Contract

A spot transaction is a contract to buy or sell a fixed amount of

foreign currency at a fixed price for a settlement that is typically two business

days.

Forward Contract

A forward contract is a contract to exchange two currencies at a

specific time in the future greater than two business days (settlement date) at a rate

fixed in advance (forward rate).

Currency Option Contracts

Currency options give you the right, but not the obligation, to buy or

sell a fixed amount of foreign currency at a specified exchange rate (strike rate) on

or within a specified time period (maturity).

Risk Hedging Santander offers the most effective management of exchange rate risk

to maximizing your profits. The solution we propose is the simplest, fastest and

most convenient way to manage your exchange rate risk, enabling you to reduce

potential fluctuations in the exchange rates of the various currencies. Santander can

20

provide all the instruments you need to set exchange rates at a future date; for more

information click any of the following options.

This refers to the organizational structure through which national

currencies are bought and sold. The principal operators are banks or financial

intermediaries, the central banks of the respective countries, brokers and

companies.

The concept of currency any means of payment (cheque, bank transfer,

etc.) denominated in a currency other than the domestic currency. The concept of

currency also encompasses foreign bank notes.

Currency fluctuations

Currencies are in constant flux owing to a series of factors such as:

Import and export operations

The socio-political situation

Economic indicators (rates of interest, inflation etc.)

Events in the money markets

Central bank interventions

Market liquidity

Basic divisions of the currency market

There are two basic segments of the foreign exchange market,

depending on the time which elapses between the making and the settling of

contracts; they comprise two specific groups of operations and two distinct prices

or exchange rates:

The spot market In this type of transaction, foreign exchange is bought and sold

against the domestic currency, and settlement is carried out up to two business

days after the contract has been made.

21

The forward market or foreign exchange insurance This refers to the buying

and selling of foreign exchange against the domestic currency, the rate of exchange

being set on the day the contract is entered into, with settlement made at some

future date starting from the third business day after the transaction is agreed.

Euro area non-financial blue chip companies systematically use financial

derivatives to hedge transaction risk. As suggested by the literature on

optimal hedging, hedge ratios seem to be close to 100% for firmly

committed cash flows and lower for estimated or expected flows. Short

maturities up to two years are most widespread for exchange rate forwards

and options, while it is not unusual to see cross-currency swaps with

maturities of a decade or more.

The management of translation risk is not completely documented and

seems to vary a lot across firms.

In their approach to longer-term economic risk, some firms rely on rolling

over of shortterm derivative hedges. Many reduce their exposure to

economic risk by matching of costs and revenues, either through financial

instruments or through the geographical structure of sourcing, production

and sales. This is in line with part of the empirical literature that suggests

that operational and financial hedges are complements. None of the

companies surveyed explicitly refers to the option value of operational

flexibility discussed in the literature on operational hedges.

22

CONCLUSION The empirical literature and the survey of non-financial companies in

the EuroStoxx50 index indicate that exposure to exchange rate variations is a

major issue for euro-area firms. This contrasts somewhat with the literature on US

corporations. It is plausible that the euro area as a more open entity is more

exposed to exchange rate variations than the US.

Euro invoicing effectively shifts transaction risk to the foreign

importers. Close to 50% of euro-area exports to countries outside the EU are

invoiced in euro, and the share of the euro is higher in exports to other EU

countries. As suggested by the literature on the optimal choice of invoicing

currency, domestic-currency invoicing of euro-area exports increased with the

introduction of the euro. At the same time, invoicing in US dollar continues to play

a much larger role than the share of euro-area exports to the US would suggest.

This paper finds hedging with exchange rate derivatives such as forwards and

options to be very widespread, in line with the literature that suggests it is effective

in reducing exposure to exchange rate risk, at least over the shorter run.

However, neither domestic-currency invoicing nor derivative

hedging easily lend themselves to managing the broader economic risk (i.e. the risk

of loss of competitiveness as a result of exchange rate fluctuations). This paper

discusses non-derivative financial hedges as well as operational hedges that

address also economic risk. The survey of large euro-area companies shows that

many make use of these instruments, in particular matching foreign currency

revenues (assets) with expenditure (liabilities) in the same currency and the

international diversification of sourcing, production and sales. Overall, this paper

suggests that euro-area exporters have instruments at hand to protect themselves

against euro appreciation and that they make ample use of them. This has probably

23

contributed to the simultaneous strength of euro-area exports and corporate profits

in the face of the euro appreciation over the past years. However, the scope for

managing medium-term economic risk is more limited than that for managing

short-term variations of the exchange rate.

Operational hedging and hedging through foreign currency loans is

almost by definition the domain of large multinational companies that have the

capacity to relocate, to tap international financial markets and dispose of

internationally accepted collateral. Real and financial globalisation is increasing

these hedging possibilities with more widespread relocation of production and

increased depth of local financial markets. What is more, the use of financial

hedges is also positively related to firm size, probably due to fix costs for setting

up a hedging function.

The EuroStoxx50 companies surveyed here are not representative for

the larger group of euroarea exporters. Smaller, less diversified exporting firms

may find it harder to manage their exchange rate risk than large multinationals.

However, recent financial market developments and technological advances (IT,

risk management techniques) have made the use of derivatives for hedging less

costly and their design easier, and the use of financial hedges by smaller firms

seems to be increasing.

24

BIBLOGRAPHY

http://forextrading.about.com/od/forexbasics/a/forex.htm

http://en.wikipedia.org/wiki/Foreign_exchange_risk

http://www.investopedia.com/terms/f/foreignexchangerisk.asp

https://en.santandertrade.com/bank-with-us/global/international-trade-

guide-risk-coverage

http://ec.europa.eu/economy_finance/publications/publication11475_en.

http://www.bis.org/publ/bppdf/bispap67l.

http://www.imf.org/external/np/speeches/2015/031715.htm

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