Risk and Portfolio Management: Foreign Exchange

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Risk is simply the possibility of loss. It can also be seen as the variability of possible outcomes from a given investment. When we make investments, we are simply taking risks but we should always endeavour to make calculated risks. Furthermore, risk is the probability that the actual return from holding an asset, whether real or financial, will deviate from that which was expected.

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More so, the greater the magnitude of deviation and the greater the probability its occurrence, the greater is said to be the risk and vice versa. Risk is present in all we do as humans and the presence of risk gives rise to uncertainty which is doubt about our ability to predict the future outcome of a current decision or action.


Management of Foreign Exchange Risk
Foreign exchange risk refers to the possibility of a fall in revenue or an increase in cost in an international transaction as a result of a change in foreign exchange rates. Multinational's fims, investors, importers and exporters are all exposed to foreign exchange risk.

The foreign exchange risk of is usually being splitted into two types of exposure, namely; accounting or translation exposure and transaction exposure. Because a multinationals foreign assets and liabilities are denominated in foreign currency units, they are exposed to losses and gains due to changing exchange rates and so are said to have accounting or translation exposure.

On the other hand, foreign exchange gains and losses resulting from international transactions are referred to as transaction exposure. Transaction exposure are shown in the income statement for the current period. The effect of these transactional gains and losses is an increase in the volatility of reported earnings per share. Three different strategies that can be us d in minimizing the transaction exposure are:

  • hedging in the forward exchange market
  • hedging in the money market
  • hedging in the currency futures market.

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