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Managing Exchange Rate Risk with VAR

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Exchange rate risk is a risk that businesses with international operations experience when there's a change in the value of one currency compared to another currency. Exchange rate risk is also known as currency risk. There are various types of exchange rate risk including translation exposure, transaction exposure, contingent exposure, and economic exposure. A company experiences translation exposure when its financial reports are impacted by changing currencies. A company experiences transaction exposure when its payables and receivables are impacted by unexpected changes in exchange rates because the contract is in a foreign currency. A company experiences contingent exposure when it has international contract negotiations or bids on international projects. A company experiences economic exposure when its market value is affected by unanticipated currency changes.

References:

Allayannis, G., Brown, G.W., & Klapper, L.F. (2000, November 19). Exchange rate risk management: evidence from east asia. Retrieved from http://papers.ssrn.com/sol3/papers.cfm?abstract_id=250719.

Allayannis, G. & Ofek, E. (2008, November 7). Exchange rate exposure, hedging, and the use of foreign currency derivatives. Retrieved from http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1296392.

State how value at risk (VAR) can be used by companies to manage exchange rate risk.

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Solution Summary

How to use Value at Risk (VAR) to oversee protection from various types of exchange rate risks ( as well as all types combined, based on algorithms) is discussed in detail. The author also provides examples of possible methods to handle the risk once it is calculated.

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VAR or Value at Risk to calculate overall risk percentage and time frame for exchange rate risk by following its specific formula to fit the situation. This includes the overall figure of potential financial loss, the probability the monetary loss would occur and the time period of this. This can be done by performing a ...

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