The Role of Financial Instruments in Reducing Exchange Rate Risk

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. DOI: 10.5901/ajis.2014.v3n2p37