Currency risk is the potential consequence from an adverse movement in foreign exchange rates (Coyle, 2000). Organizations are exposed to currency risk when involved, directly or indirectly, in international trade and finance. Currency risk arises because exchange rates are volatile in the short and the long-term and the future movements of exchange rates cannot be predicted. Companies will as a result suffer losses due to adverse exchange rate movements when exposed to foreign currencies (Coyle, 2000).
Hedging is the term used to describe the actions that reduce or eliminate an exposure to risk (Coyle, 2000). Common ways of hedging currency risk involve:
- transferring the risk to your trading partner by placing the transaction in your domestic currency
- structurally hedging your risk by off setting income against expenditure in the same currency
- purchasing derivatives in the foreign exchange market (Coyle, 2000)