Any company that conducts at least some of its business in another currency is exposed to currency forex risk (or foreign exchange risk, or exchange rate risk). However, this risk is present only if the company's sales currency differs from the company's cost currency – if a company's revenues and expenses are both denominated in the same foreign currency, there is no foreign exchange risk. There are two types of currency risk: transaction risk and translation risk. Transaction risk refers to actual conversions of cash flows from one currency to another, and the extent to which exchange rate changes will affect a company's cash flow. Translation risk is more of an accounting issue, and refers primarily to the impact of exchange rates on earnings and balance sheet items when consolidating financial statements from foreign subsidiaries. From a business standpoint, transaction risk is the more relevant of the two. There are five general types of risk that are faced by all businesses: market risk (unexpected changes in interest rates, exchange rates, stock prices, or commodity prices), credit/default risk; operational risk (equipment failure, fraud); liquidity risk (inability to buy or sell commodities at quoted prices); and political risk (new regulations, expropriation). Businesses operating in the petroleum, natural gas, and electricity industries are particularly susceptible to market risk—or more specifically, price risk—as a consequence of the extreme volatility of energy commodity prices. Electricity prices, in particular, are substantially more volatile than other commodity prices. Country risk can be divided into two parts, economic risk and political risk. Economic risk refers to the stability of a country's economy. It embodies concerns such as dependence on individual industries or markets, the ability to sustain a vibrant level of activity and to grow, and the supply of natural resources and other important inputs. Political risk is more concerned with the stability of the government that manages the economy. It encompasses concerns such as the ability to move capital in and out of the country, the likelihood of a smooth transfer of power after elections, and the government's overall attitude toward foreign firms. Obviously, these two branches of country risk overlap significantly. There are a variety of services that provide in-depth assessments of country risk for virtually every country; multinational firms make considerable use of these services to form their own decisions regarding international projects. Protective measures to guard against transaction exposure include: - forward contracts
- price adjustment clauses
- currency options
- borrowing and lending in the foreign currency
- invoice in home currency
A common problem in managing currency risk is that companies only realise that they have a risk when the exposure has been generated. However, currency risk management should begin before exposure risks have been generated otherwise fundamental operating decisions have been taken on the basis of complete information. Companies approaches to exposure vary widely; perhaps by the nature of the business, the competition or the culture of the company. A company could accept a high degree of risk and expect commensurate returns or it could be very risk averse and be prepared to pay quite a high price for certainty. Indeed it may have no stance on currency at all and take everything as it comes with a 'swings and roundabouts' approach. If a company decides to take an active approach to foreign currency management this will centre around the concept of hedging. Hedging a particular currency exposure means establishing an offsetting currency position such that whatever is lost or gained on the original currency exposure is exactly offset by a corresponding foreign exchange gain or loss on the currency hedge. Volatile foreign earnings can cause volatile growth which is more costly than slow stable growth. Hedging can reduce the company's volatility of cash flows because the company's payments and receipts are not forced to fluctuate in accordance with currency movements. This can, in the extreme, reduce the possibility of bankruptcy and therefore allow easier access to credit and lower interest payments due to lower perceived risk. Hedging should also allow for greater certainty about future receipts and payments and consequently enhanced budgetary decisions. Most hedging strategies are costly in terms of fees, premiums or the time involved. Derivatives allow investors to transfer risk to others who could profit from taking the risk. The person transferring risk achieves price certainty but loses the opportunity for making additional profits when prices move opposite his fears. Likewise, the person taking on the risk will lose if the counterparty’s fears are realized. Except for transactions costs, the winner’s gains are equal to the loser’s losses. Like insurance, derivatives protect against some adverse events. The cost of the insurance is either forgone profit or cash loses. Because of their flexibility in dealing with price risk, derivatives have become an increasingly popular way to isolate cash earnings from price fluctuations. The most commonly used derivative contracts are forward contracts, futures contracts, options, and swaps. A forward contract is an agreement between two parties to buy (sell) a specified quality and quantity of a good at an agreed date in the future at a fixed price or at a price determined by formula at the time of delivery to the location specified in the contract. Forward contracts have problems that can be serious at times. First, buyers and sellers (counterparties) have to find each other and settle on a price. Finding suitable counterparties can be difficult. Discovering the market price for a delivery at a specific place far into the future is also daunting. Second, when the agreed-upon price is far different from the market price, one of the parties may default (“non-perform”). As companies that signed contracts with California for future deliveries of electricity at more than $100 a megawatt found when current prices dropped into the range of $20 to $40 a megawatt, enforcing a “too favorable” contract is expensive and often futile. Third, one or the other party’s circumstances might change. The only way for a party to back out of a forward contract is to renegotiate it and face penalties. Futures contracts solve these problems but introduce some of their own. Like a forward contract, a futures contract obligates each party to buy or sell a specific amount of a commodity at a specified price. Unlike a forward contract, buyers and sellers of futures contracts deal with an exchange, not with each other. | 
