Over the past half century, the direct investment in foreign countries has grown and with it has arisen financial risks due to foreign currency fluctuations. Although there have been periods of single-country dominance in outward investment (the United Kingdom between the 1880s and 1914, and the United States in the 1950s and 1960s), perhaps more significant has been the consistent growth of multinational operations over the past century (Jones 1996). Many of the large international companies such as Coca-Cola and Nestle must keep track of the value changes when currency is exchanged. This risk of fluctuation carries the factor of time as well. If they are not able to lock in the value of the currency at the time of the sale and recognizes the receivable.
Three types of risk of this foreign exchange exposure are economic, transaction and translation. The Transaction exposure risk is quite simple and straight forward. If a company purchases a good from a foreign country valued in the foreign country’s currency, then the value can be affected by any fluctuations in the foreign currency. If the foreign currency rises, then the cost will rise simultaneously. The translation risk is a parent company must consolidate a subsidiary’s financials which is in foreign currency. Again, the overall financials can be affected by fluctuations in currency. The economic risk is when a company’s fair market value is exposed to movements in currency in other countries. A beer manufacturer in Argentina that has its market concentration in the United States is continuously exposed to the movements in the dollar rate and is said to have an economic foreign exchange exposure (Sandler 2019).
Companies have had plenty of experience in these risks and have discovered ways to mitigate the effects of currency fluctuations. Companies will use futures or forward contracts, options or swaps to hedge against the risk. “For example, company A is based in the United States and company B is based in England. Company A needs to take out a loan denominated in British pounds and company B needs to take out a loan denominated in U.S. dollars. These two companies swap to take advantage of the fact that each company has better rates in its respective country. When these two companies swap, they will be able to save on interest rates by combining the privilege they have in their own country's market” (Cheungcorp, 2017).
Geoffrey J. (July 1996). The Evolution of International Business: An Introduction. London and New York: Routledge, 1996. xii + 360 pp
Sandler, K. (January 2019). Three Types of Foreign Exchange Exposure. Retrieved from https://bizfluent.com/list-6651707-three-types-foreign-exchange-exposure.html
Cheungcorp. D. (September 2017). How to Reduce Foreign Exchange Risk. Retrieved from https://bizfluent.com/info-7898532-leading-lagging-foreign-exc