THE ROLE OF FINANCIAL INSTRUMENTS IN REDUCING EXCHANGE RATE RISK

Abstract

ct:  
Companies that transact in different currencies face financial risk because 
of unpredictable exchange rate fluctuations. Exchange rate risk constitutes one of 
the most common forms of risk that firms in the international arena encounter and, 
in recent years, the management of this risk has become one of the key factors in 
overall financial management. 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 main purpose of this paper is to show the role of derivatives in 
reducing exchange rate risk. This paper treats the nature of these financial 
instruments and shows how they can be used to manage foreign exchange risk or 
enter into speculative positions of currencies movements. 
Keywords: foreign exchange risk; hedging; international trade; risk 
management; forward and future contracts