Exchange Rate Risk Measurement and Management: Issues and Approaches for Firms

IMF Working Papers, November 1, 2006

Source details

Canonical URL

Exchange Rate Risk Measurement and Management: Issues and Approaches for Firms

Other formats

• Markdown version
• Structured JSON version
• Bundle manifest

Bibliographic details

• Authors: Michael G. Papaioannou
• Published: November 1, 2006
• Series: IMF Working Papers
• DOI: https://doi.org/10.5089/9781451865158.001

Summary

• 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.
• The paper reviews traditional types of exchange rate risk faced by firms: transaction, translation and economic risks.
• The VaR approach is presented as the currently predominant method of measuring a firm's exchange rate risk exposure.
• The paper examines advantages and disadvantages of various exchange rate risk management strategies, including tactical versus strategical and passive versus active hedging.
• 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 provides some data on the use of financial derivatives instruments, and hedging practices by U.S. firms.

Key themes and findings

• Types of exchange rate risk:
  • Transaction risk
  • Translation risk
  • Economic risk
• Measurement approach emphasized:
  • Value-at-Risk (VaR) is identified as the currently predominant method for measuring firms' exchange rate risk exposure.
• Hedging strategy classifications discussed:
  • Tactical versus strategical hedging
  • Passive versus active hedging
• Markets and instruments:
  • Main hedging instruments in OTC markets
  • Main hedging instruments in exchange-traded markets
• Empirical content:
  • Provides data on the use of financial derivatives instruments
  • Documents hedging practices by U.S. firms

Best practices and policy-relevant recommendations (as outlined)

• Adopt a systematic measurement framework for exchange rate exposures (paper highlights VaR as predominant).
• Distinguish between transaction, translation, and economic risks when designing risk management policies.
• Evaluate trade-offs between tactical and strategical hedging approaches.
• Consider the implications of passive versus active hedging for firm objectives and costs.
• Use a mix of OTC and exchange-traded instruments appropriate to the firm's exposures and counterparty considerations.
• Monitor and document hedging practices and use of financial derivatives to inform governance and controls.

Publication and metadata

• By Michael G. Papaioannou
• November 1, 2006
• Pages: 20
• Volume: 2006
• Issue: 255
• Series: Working Paper No. 2006/255
• DOI: https://doi.org/10.5089/9781451865158.001
• Stock No: WPIEA2006255
• ISBN: 9781451865158
• ISSN: 1018-5941
• Subjects: Currencies, Exchange rate risk, Foreign currency exposure, Foreign exchange, Hedging
• Keywords: cash flow, currency, currency risk, economic risk, exchange rate, WP

IMF Working Paper — Exchange Rate Risk Measurement and Management: Issues and Approaches for Firms (Michael G. Papaioannou, November 1, 2006).

Content in this bundle

• Wp06255
  • Wp06255 (Markdown version)
  • Wp06255 (PDF)