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FOREIGN EXCHANGE RISK MANAGEMENT TECHNIQUES FOR MNCS
1.0 Overview of Foreign Exchange Risk
1.1 Sources of foreign exchange risk exposure
Foreign exchange risk means that the possible unfavorable changes in the exchange rates could
affect the financial wellbeing of the multinationals. Adler and Dumas (1984) describe currency
risk exposure as the possibility of a firm's cash flows, revenues, and assets to be affected by the
fluctuations of the exchange rates. Foreign exchange risk exposure can be found in transaction,
economic, and translation exposure (Adler & Dumas, 1984). Transaction exposure is the type of
exposure that is caused by the contracts that are dependent on foreign currencies, and it affects
the value of the cash flows when the exchange rates change (Acharya et al. , 2013). Unlike
economic factors, the economic exposure plausibly is the consequence of currency movements
which affect the competitive position and the market value of MNCs assets and liabilities (Aretz
et al. , 2007). Translation exposure is caused by the translation of foreign currency-denominated
financial statements into the reporting currency, hence, the fluctuations in reported earnings and
the book values (Allayannis et al. , 2012). Foreign exchange risk can greatly affect multinational
corporations, which will be reflected in their profitability, competitiveness, and shareholder
value. According to Abor (2019), the effective risk management strategies are the key
components of the currency risk exposure causing the negative effects. The uncontrolled foreign
exchange risk can cause the MNCs to face more costs, lower margins, and the cash flow
generation problem (Abor, 2019). Besides, the exchange rate fluctuations can lead to the
reduction of the value of the assets and investments held in different currencies, thus, affecting
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the balance sheets and financial stability of MNCs (Acharya et al. , 2022). Besides the financial
risk it presents, foreign exchange risk can also influence the strategic decision-making,
investment planning, and capital allocation for MNCs operating in the global markets (Aretz et
al. , 2007). The foreign exchange risk being the most important thing for MNCs, they use various
ways to reduce the foreign exchange risk in their dealing. Acharya et al. (2013) point out the use
of forwards, options, and swaps, which are the types of currency derivatives, as the common
hedging instruments that are used for transaction exposure management.
1.2 Transaction, economic, and translation exposure
MNCs face the problems of economic, transaction and translation exposure. The transaction
exposure is the reason behind the profitability of every transaction and can be the cause of cash
flow volatility (Allayannis, Lel, & Miller, 2012). Economic exposure has a great impact on the
long-term competitiveness and value of MNCs because it has a direct effect on the demand for
their products and services in foreign markets (Aretz, Bartram, & Dufey, 2007). Translating
exposure affects the precision of the financial reporting and can be a cause of wrong evaluation
of a company's performance and the financial position (Adler & Dumas, 1984). Besides,
transaction exposure is the one which arises from the contractual obligations denominated in
foreign currencies, the foreign exchange rate fluctuations can affect the cost of imported
materials, sales revenues from exports and the value of debt obligations (Allayannis, Lel, &
Miller, 2012). The ways of managing transaction exposure by MNCs could be through hedging
strategies like the forward contracts, currency options, or swaps which they can use to reduce
potential losses and to stabilize cash flows (Allayannis, Lel, & Miller, 2012). Besides transaction
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exposure, economic exposure is the change in the competitive position of MNCs and profitability
over the long term due to the movement of exchange rates (Aretz, Bartram, & Dufey, 2007).
MNCs' products and services demand, production cost of imported inputs, and competitive
pricing have undergone changes as a result of the fluctuations in exchange rates (Aretz, Bartram,
& Dufey, 2007). To handle the issue of economic exposure, MNCs may adopt certain strategic
initiatives like differentiation of products, geographic diversification, or operational adjustments
to adjust to the market conditions and to remain competitive (Aretz, Bartram, & Dufey, 2007).
Besides, translation exposure results from the process of combining the financial statements of
foreign subsidiaries into the reporting currency of the MNC, thus, the earnings and net assets of
the corporation can fluctuate (Adler & Dumas, 1984).
1.3 Impact on multinational corporations (MNCs)
The foreign exchange risk exposure of MNCs is the most important issue and its effects are
numerous and complicated. The exchange rate shift is the factor which can influence, directly,
the revenue, costs, and profitability of the company, which, finally, will affect the shareholder
value (Acharya, Almeida, & Campello, 2013). The unpredictable nature of exchange rates can
make the decision-making process bad and the planning of investments unclear, thus resulting in
the resources being not properly allocated (Abor, 2019). The foreign exchange risk is a type of
risk that can be considered as a danger to investor confidence and a cause of the increased costs
of capital for MNCs (Allayannis, Lel, & Miller, 2012). On the other hand, exchange risk can be
one of the reasons of operational problems for MNCs, which will affect the supply chain
management, pricing strategies and the financial reporting (Adler & Dumas, 1984). The reason
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for the changes in the cost of inputs that are purchased from the foreign markets can be the
exchange of currencies and this will affect the major compression or the pricing of the product to
stay competitive (Adler & Dumas, 1984). The translation of financial information in different
currencies is a task that has to be done with care since the currency translation methods and the
possible effect on the reported earnings and balance sheet figures (Adler & Dumas, 1984) are
part of it. Besides, the silver lining of the foreign exchange risk is not only financial but also
strategic, and this, in turn, impacts the market expansion and the international growth strategies
that are getting affected. The currency volatility might be the cause of the fact that some foreign
markets are not good to invest or expand into, and this can affect the MNCs strategy to diversify
their markets and make a choice of which market to enter (Aretz, Bartram, & Dufey, 2007).
Besides that, the foreign exchange risk can also change the value of the cross-border M&A deals,
thus, the deal economics and integration plans are also altered (Aretz, Bartram, & Dufey, 2007).
In short, the foreign exchange risk must be handled by MNCs in a proactive manner, to be able
to keep the competitiveness, protect the shareholders value and to attain the sustainable growth
in the global market.
1.4 Importance of effective risk management strategies
The main thing is to be able to manage the foreign exchange risk exposure well for the
multinational corporations in order to be able to deal with the difficulties of the global markets
and thus to protect the financial performance of the company. By using the instruments such as
currency derivatives, MNCs can hedge against the currency risk and protect themselves from the
transaction and economic exposure, thus, they can avoid the risks of future payments
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(Allayannis, Lel, & Miller, 2012). These instruments are meant to provide stability and
predictability to financial operations, hence they are the insurance policy against sudden changes
in the currency values. Besides, the diversification of revenue sources and production facilities
across different countries reduces the MNCs' dependency on one currency and thus, the
exchange rate fluctuations (Acharya, Gabor, & Skeie, 2022). Through the decentralization of the
operations, the firms can cut the impact of the bad currency movements in the particular markets
and thus, the companies will be able to overcome the market situations and will be able to adapt
to them. Besides the operational strategies, the proactive financial policies and the strong
corporate governance structures are the main instruments that strengthen the MNCs' foreign
exchange risk resistance (Aretz, Bartram, & Dufey, 2007). Risk management protocols and the
promotion of a culture of transparency and accountability in the organization will help the firms
to deal with currency risk exposure more efficiently. Thus, these measures not only save MNCs
from possible losses but also build the investor confidence and, hence, lead to the long-term
value creation. All in all, a risk management approach that is complete in its scope covers the
financial, the operational, and the governance aspects, thus, making the MNCs ready for the
foreign exchange risk which they are likely to face and at the same time, it enables them to take
the global opportunities. Through the adoption of a holistic vision and the integration of the
different risk management strategies, MNCs can successfully cope with the foreign exchange
risk and at the same time, stay ahead of the other companies in the world that are now in a global
business world that is becoming more and more volatile.
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2.0 Internal Hedging Techniques
2.1 Netting and matching of cash flows
The netting and matching of cash flows are the vital techniques which the multinational firms
use to effectively deal with exchange rate risk. Bare, Bodnar and Kaul (1996) illustrate netting,
which is the activity of offsetting cash surpluses against cash deficits in the foreign currencies,
thus, the company's total currency risk is minimized. The process of not only limiting the
transaction costs that are connected to the conversion of currencies but also the elimination of the
effect of the exchange rate movements on the cash flows is the method of the financial gains that
is free of the risks. Besides, Bartram, Brown, and Minton (2010) highlight the matching, which
means the process of matching the cash inflows and outflows in order to reduce the need for
currency conversion and thus, to lower the exposure of the firm to the exchange rate risk. The
reliable netting and matching of cash flows, which is a must for multinational corporations, will
result in the improvement of their risk management techniques and will, therefore, promote the
financial performance. The Netting method aids the companies to make their cash flow
operations simpler by merging the transactions that are in different currencies hence, it cuts the
complex and the business becomes more efficient (Bartov, Bodnar, & Kaul, 1996). In this way,
the currency flows are balanced, and the firms can lessen the impact of the exchange rates
fluctuations on their cash position, hence, they can create a certain stability during the times of
currency volatility. Apart from that, the connection of cash inflows and outflows can be made,
which in turn helps the firms to manage their transactions at the proper time thus the reason for
currency conversion is less and the exposure to unfavorable exchange rate movements is reduced
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(Bartram, Brown, & Minton, 2010). Thus, the company not only saves on cash flow
management, but also prepares itself for the market unpredictability and fluctuations.
2.2 Leading and lagging of payments/receipts
The two principal techniques used by multinational corporations in order to deal with exchange
rate risk exposure are the leading and lagging of payments and receipts. Bodnar, Dumas, and
Marston (2002) argue that most of the leading is related to the acceleration of the settlement of
foreign currency payments or the postponement of the settlement of foreign currency liabilities
in order to benefit from the favorable movements of exchange rates. On the other hand, the
writer of the article argues that lagging is the deferring of the foreign currency payments or the
speeding up of the foreign currency liabilities payment in order to diminish the chances of losses
that may come from the unfavorable fluctuations in the exchange rates. The strategic measures of
the firms enable them to maximize the use of the short-term currency value movements, thus, the
cash flow dynamics of the firms become more efficient and the dependence on the currency risk
is reduced. The process of prudent planning of payment and receipt dates helps multinational
corporations to enjoy the benefits of the exchange rate fluctuation while at the same time
protecting themselves from the possible losses that may arise from the change in the value of
money. With the relation of the payment and receipt timings to the exchange rate trends, firms
can be able to have a buffer of financial resilience and a stronger ability to cope with the
complex dynamics of the global currency markets. Furthermore, the shift of the introduction of
the leading and lagging strategies implies that the proactive risk management practices are the
main tool of risk mitigation in the risk management systems of multinational corporations. By
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adopting these measures, firms can not only fine-adjust their financial performance but at the
same time, also boost their competitive positioning in the global market today. Thus, through the
use of the leading and lagging techniques, multinational corporations can better safeguard their
finances and profit from the opportunities created by the dynamic changes in exchange rates, and
hence, the whole process will be the backbone of their sustained growth and profitability.
2.3 Pricing policies and currency risk sharing
The policies of pricing and the currency risk-sharing mechanisms are the main factors that
MNCs are trying to overcome in order to effectively manage the exchange rate risk. As
Benavides, Leon, and Rullan (2019) stated, the firms can adjust their pricing strategies to avoid
the currency risk, thereby, shifting the currency risk to the customers or suppliers. This is the
strategy that has been reoriented towards the inclusion of currency clauses in the contracts to
transfer the exchange rate exposure to the customers or suppliers, which in turn lessens the firms'
vulnerability. Besides, as noted by Bartram et al. (2010), the currency risk-sharing agreements
with the business partners are the strategies for the realization of the distribution and the
reduction of the exchange rate risk that is spread throughout the supply chain. By applying the
right prices policies and introducing the currency risk-sharing arrangements, MNCs can thus
cover the exchange rate risk and strengthen their position in the international market. These
strategic plans do not only decrease the harm of the currency volatility but also make the firm
more durable and agile in the complex global currency markets. Through the use of pricing
mechanisms and the establishment of risk-sharing agreements corporations are going to manage
their exchange rate risk in a proactive manner thus they are going to be able to protect their
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financial interests and to take advantage of the opportunities for growth and profitability that are
sustainable. Through the introduction of sound pricing policies and the currency risk-sharing
mechanisms into their risk management frameworks MNCs can cope with the exchange rate
fluctuations and therefore, they can strengthen their market position and generate value creation
across their global operations. Furthermore, through the adoption of a proactive attitude towards
exchange rate risk management MNCs can improve the confidence of stakeholders and thus,
strengthen their reputation as reliable and resilient market participants. Therefore, the usage of
the pricing policies and the currency risk-sharing mechanisms can be effectively applied by the
multinational corporations to overcome the challenges caused by exchange rate volatility and
hence come out with a stronger position in the global marketplace.
2.4 Operational hedging and diversification strategies
The operational hedging and diversification are the main elements which will be the basis for
long-term exchange rate risk management in the multinational firms. Scholarly work by Bartov
et al. (1996) explains the process of the diversification of the production facilities or sourcing
from various countries, which, as a result, diminishes the dependence on a single currency or
location. The method enables agencies to diversify their exposure to the exchange rate
fluctuations of different currencies and geographical areas, therefore, the resilience against
currency volatility is strengthened. Besides, the allocation of the revenue sources on the different
markets is another way of the protection from the negative effects of the exchange rate changes
on the total profit, as Benavides et al. (2019) indicate. By employing the operating hedging and
diversification strategies, the multinational corporations will be able to easily manage the
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exchange rate risk, and therefore, they will become more stable and perform better in the
international market. Thus, by executing these strategic initiatives, companies not only cut the
negative effects of currency fluctuations, but also, at the same time, they will be able to gain
from the opportunities offered by different markets and thus, they will be able to create value and
growth over a long period of time. The multinational corporations can get a significant benefit in
managing the exchange rate risk in advance by operational hedging and diversification thus, the
competitiveness of the multinational corporations will be increased and the stakeholders will be
confident in these corporations. The businesses show their resilience and adaptability to the
changes in the world market by the adoption of the aforementioned tactics, therefore the long-
term success and profitability of the firm is ensured.
3.0 External Hedging Techniques
3.1 Forward contracts and currency futures
Forward contracts and currency futures are the most often used by multinational firms as the
main means to ease the worries that are connected to the changing of the exchange rates. As per
Campbell, Medeiros, and Viceira (2010), forward contracts let these firms obtain a certain
exchange rate for a specified amount of currency which in turn helps them to guard themselves
from the negative effects of exchange rate fluctuation. In the same way, currency futures
contracts, which are traded on the organized exchanges, give firms a way to hedge currency risk
by agreeing to buy or sell a definite amount of currency at a certain price and a specific future
date (Eiteman, Stonehill, & Moffett, 2022). Through the use of these financial instruments, the
multinational firms can, in a way, limit the impact of exchange rate fluctuations on their cash
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flows in the foreign currency transactions and thus, ensure the stability of their cash flows.
Because of the already existing forward contracts and currency futures, firms could manage the
uncertainties of global currency markets more easily and with more confidence and assurance,
thus, guaranteeing the consistency and reliability of their financial operations across borders.
Through these instruments, companies can get the future exchange rates, thus the firms will be
protected from the financial risks in international transactions. Financial instruments are used as
a tool by the multinational corporations to manage their exposure to exchange rate fluctuations
effectively and as a result, their cash flows associated with foreign currency transactions are
stabilized. The companies can protect themselves from the risks that come with the fluctuation of
exchange rates through the use of forward contracts and currency futures, and this way they can
fully enjoy the business of the international market with comfort and efficiency.
3.2 Currency options and option strategies
The currency options and option strategies give multinational firms the additional opportunity to
handle the exchange rate risk. As Choi and Prasad (1995) have written, a currency option is a
right, but not an obligation, of a firm to buy or sell a certain currency at a pre-set exchange rate
within a given period. Through this firms can safeguard themselves from the bad exchange rate
movements while keeping the chance to take advantage of the good ones. To take an example, a
firm which is expecting a possible depreciation of a foreign currency can buy a put option to sell
that currency at a fixed exchange rate so that the losses can be reduced. Contrary to this, if there
is an anticipation of currency depreciation, the company can purchase a put option to sell the
currency at a bad rate, thus, it can take advantage of the expected loss. Options strategies like
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collars and straddles allow the firms to hedge their own risks in a way that they prefer and have a
diversified view of the market (Chernenko & Faulkender, 2011). A collateral strategy is a
technique that one uses to buy a put option and write a call option on the same currency, thus, at
the same time, decreasing the possible loss and the possible gain that can be obtained from the
exchange rate movements. Contrarily, a straddle strategy is characterized by the buying of both a
put option and a call option with the same exercise price and expiration date, thus, companies
can reap benefits from the big exchange rate changes in either side. Through the use of currency
options and option strategies into their risk management system, multinational corporations can
increase their chances of reducing the exchange rate risk and getting the best risk-return ratio.
These instruments give firms the opportunity to cope with the shifts in exchange rate with the
utmost flexibility and precision, thus, they are able to deal with the intricacies of world trade at
the best of their possibilities and in the most of the best of ways.
3.3 Currency swaps and cross-currency swaps
Currency swaps and cross-currency swaps are quite complicated financial tools that are used by
big firms to cope with the exchange rate risk and to lower the funding costs of their projects.
Davies and Studniberg (2018) explain that in currency swaps you exchange the cash flows of
two different currencies that are linked by the predetermined terms and conditions. This among
others is the mechanism that aids the firms in hedging the currency exposure that results from the
financing activities like the debt issuance or the project financing. To take an instance, if a
company has got a loans in a foreign currency but mainly operates in its domestic currency, it
can go into a currency swap to convert its foreign currency debt payments into its domestic
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currency and thereby, it will be able to protect itself from the impact of the bad exchange rate
movements. The other side of the coin is that cross-currency swaps help firms to convert one
currency into another at the pre-arranged exchange rate for a certain period which in turn helps in
the management of two risks at the same time (Döhring, 2008). Through the usage of these
instruments, multinational companies can attain the better match between their assets and
liabilities in the different currencies, thus, they will be able to reduce the exchange rate risk and
at the same time they will be able to improve the capital structure. Cross-currency swaps are
specially useful for firms that have different bureaus in different countries with different
currencies and thus they will get the advantage to streamline their funding and enhance the
financial stability. Through the proper management of exchange rate risk, multinational
companies can boost investors' trust and get access to the capital markets worldwide in a more
efficient way. Currency swaps and cross-currency swaps are the main tools that allow
multinational corporations to face the difficulties of global financial markets while at the same
time controlling the exchange rate risk and getting the best rate of return for their capital.
3.4 Debt and equity-linked instruments
Debt and equity-related instruments give the multinational firms a new way to hedge exchange
rate risk and at the same time, they are able to access the capital markets. The authors, Eiteman,
Stanley, and Moffett (2022), explain how companies can raise funds through the issuance of debt
securities like eurobonds or foreign currency-denominated bonds to make their currency risk and
revenue alignment. For example, if a multinational corporation generates a large portion of its
revenue in euros, it can issue euro-denominated bonds that will be liabilities for the same in euro
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thus reducing the risk of adverse exchange rate movements that are of the euro-denominated
income of the corporation that could affect its debt obligations. The same thing, another example
is the equity-linked instruments like the foreign currency convertible bonds or the global
depositary receipts which are the other sources of the firms funding besides the equity and the
exchange rate risk is also mitigated (Davies & Studniberg, 2018). These instruments help
businesses to obtain funds in foreign currencies without being fully dependent on the currency
fluctuations, since the change of debt or equity into the issuer's home currency is postponed until
a later date or triggered by certain conditions. Through the judicious use of debt and equity-based
instruments, multinational companies can achieve the perfect capital structure, reduce the risk of
the exchange rate fluctuations and become more competitive in the global market. To illustrate, a
company that is on the conservative side of the risk continuum would prefer to issue fixed-rate
eurobonds in order to lock in favorable interest rates and mitigate interest rate risk while a more
aggressive firm would opt for the convertible bonds in order to gain cheaper funding and take
part in the possible equity upside. In general, debt and equity-linked instruments are the
backbone of the multinational corporations that manage the exchange rate risk efficiently and at
the same time enter all the different sources of funding to support their global growth initiatives.
4.0 Risk Measurement and Monitoring
4.1 Value-at-Risk (VaR) and stress testing
The VaR and stress testing are among the main techniques used by the multinational firms to
measure and control the exchange rate risk. VaR is the method that Graham and Harvey (2001)
use to show that the maximum loss of the value of a portfolio in the given time horizon at the
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specified confidence level is calculated. Multinational corporations use VaR to find out the effect
of the exchange rate movements on their financial statements and finally set the risk limits
accordingly. For example, a company having a lot of foreign currencies may use VaR to predict
the loss in the portfolio value due to the unfavorable exchange rate movement and to determine
the risk limits to make sure of the protection of the shareholders value. Stress testing, as stated by
Froot, Scharfstein, and Stein (1993), is the procedure of creating extreme market situations to
check the firm's portfolio resilience in face of adverse events. The pressure on their portfolios
from different stress situations, for example, the sudden devaluation of the currency or the
geopolitical crises, the firms can discover their weaknesses in the risk management strategies and
they can take the necessary steps to avoid the potential losses. VaR and stress testing are the two
concepts that if a multinational firm would include in its risk management framework then it
would be able to improve its capacity of the exchange rate volatility and thus, it would be able to
anticipate and respond to it properly. VaR and stress testing are the means through which firms
comply with the regulatory requirements and prove their adequacy to manage the exchange rate
risk to the stakeholders which include investors, creditors, and regulatory authorities. The
inclusion of VaR and stress testing into the risk management of multinational firms is a very
important factor in the security of these firms to exchange rate fluctuations and in the long term
their staying in the global marketplace.
4.2 Scenario analysis and sensitivity analysis
The two methods of scenario analysis and sensitivity analysis are the integrated ones which are
used in multinational firms to study the impact of exchange rate risk on their operations and
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financial performance. Scenario analysis is a process that helps in making the future exchange
rate movements possible and studying their effects on the cash flows, profitability, and valuation
of the firm; this is the definition of the author (Zhang, 2017) of the paper. For instance, a
multinational company in different countries can do scenario analysis to find the effect of the
exchange rate changes on its revenue and expenses, therefore it can detect the problems and the
benefits of the different market it is in. This research can be connected to the occurrences such as
the unanticipated currency boom or slump, the gradual growth of trends or even the extreme
cases of currency crises. The sensitivity analysis is a process that has been introduced by Zhu
and Yang (2016) as a technique of determining the sensitivity of the vital financial figures like
the earnings and cash flows to the changes in the exchange rate. Hence, firms can, with the most
important sources of exchange rate risk, find the sources of exchange rate risk and then target
their risk management activities to those sources. For instance, a company could put sensitivity
analysis to the test to find out the result of changes of the exchange rates on its profits and
therefore, modify its hedging policies in order to prevent the possible losses. Hence, the scenario
analysis and the sensitivity analysis are the same with the decision-making process of the
multinational firms, which makes them more resilient to the exchange rate fluctuations and
therefore they can make more informed strategic choices. These methods are the main tools for
the companies to forecast and regulate the changes in the currency markets, thus, the companies
can easily deal with the complicated nature of the international business environments and make
the long term profit and the growth possible.
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4.3 Exposure monitoring and reporting systems
The exposure monitoring and reporting system are the essential parts of multinational firms' risk
management infrastructure of the exchange rate. According to Zhou and Wang (2013) the real-
time monitoring of foreign currency exposures is of great importance because it allows to find
out the problems in advance and to take the actions to solve them as soon as possible. To give an
example, a multinational corporation that has operations in different countries can use the
exposure monitoring systems to collect its foreign currency exposures from all subsidiaries and
business units and thus, have a complete picture of the total currency risk exposure. Thus, a long-
term approach of such a system enables the firm to swiftly find out the potential areas of
vulnerability and accordingly, implement the appropriate hedging strategies to neutralize the
risks. Besides, strong reporting systems give the management with the necessary and the on-time
information on the firm's exchange rate risk profile, hence, the management is able to make the
decision accordingly and also communicate with the stakeholders effectively. Management can
use these reports as a tool to check whether the firm is exposed to exchange rate movements,
check the efficiency of the hedging strategies existing and make the necessary adjustments when
the risk is to be reduced. Through the introduction of the system of exposure monitoring and
reporting, multinational firms can improve their transparency, accountability, and in the end, the
risk management efficiency. The adoption of these systems allows companies to make timely
identification and handling of the possible vulnerabilities, thus they can smoothly move through
the ups and downs of the exchange rate volatility and keep their financial stability in a world that
is more and more global. Besides, the establishment of efficient exposure monitoring and
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reporting systems can also be a source of competitive advantage for a company as it will provide
management with the necessary information about the market trends and opportunities which in
turn will be used to make the strategic decisions that will support the company in the long term
and at the same time it will be able to increase its profit.
4.4 Accounting and regulatory considerations
The fact that accounting and regulatory aspects are the main factors that are responsible for the
formation of the exchange rate risk management practices in multinational firms is really not
difficult to understand. Ellul, Wang, and Zhang (2019) stress the significance of the risk
management policies and processes that are in the line with the requirements of the accounting
standards and the regulatory requirements to make sure that the company is in compliance and
justice. Firms should measure and disclose their foreign currency exposures in the financial
statements, so that the investors can clearly see their risk profile. The openness of the situation is
very important for the investors to get the necessary information to decide about the investments
in the multinational companies. Besides, regulation on derivatives use and capital adequacy
constraints are the restrictions on firms' risk-taking activities and demand the strong risk
management processes. As an example, regulatory bodies may be compelled to use some
particular hedging instruments or they may set the limit on the amount of risk that firms can take.
The adherence of multinational firms to accounting standards and regulatory guidelines can
boost their credibility, decrease legal and reputational risks, and thus, it will be easier for
investors to have faith in their ability to handle exchange rate risk. Consequently, multinational
firms have to set the accounting standards and regulatory guidelines as their priority in the
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exchange rate risk management. Furthermore, the active interaction with the regulators and
stakeholders can be the basis to make the firms aware of the changes in the regulatory
requirements and the risk management practices of the firms can remain so in line with the
evolving standards and expectations. Generally, the accounting and regulatory requirements are
the backbone of the design and the execution of the exchange rate risk management strategies for
multinational firms, thus, the openness, compliance and the investor confidence in the global
marketplace are guaranteed.
5.0 Designing an Effective FX Risk Management Program
5.1 Defining objectives and risk tolerance levels
The main elements of an FX risk management program are clear goals and the respected risk
tolerance levels which are already the basis of the effective management of FX risk, as shown by
Ziemba and Cai (2022). These parameters form the general principles for establishing the
centralization or decentralization choice, a choice that is affected by factors such as the
operational complexity and the regional risk (Zou & Huang, 2022). The course that the company
selected, either centralized or decentralized, should be in accordance with the company's goals
and risk appetite, therefore, making the resource allocation and decision-making process more
effective. The consolidation of all the currency exposure management activities under one
treasury function, which leads to the standardization of the processes, the enhanced control, and
the better visibility of the risks across the organization is the main idea of the Centralized FX risk
management. The other hand, the FX risk management is decentralized so that the business units
or the subsidiaries can have a greater autonomy in managing their currency exposures,
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considering their individual operational requirements and market conditions. This model can be a
better one for firms with different business fields or regional activities that need to have the
hedging strategies designed for them. No matter what the chosen approach is, it is very important
to have the communication and coordination between the central treasury functions and the
business units. This is because, it will be the main thing that will make sure that they are in line
with the corporate objectives and the level of risk that they can take. Besides, the observation and
evaluation of FX risk exposures, the achievement of the objectives and the compliance with the
risk limits are of great importance in order to preserve the efficiency of the FX risk management
program. Through the way of setting up of clear objectives and defining the risk tolerance levels
and choosing the right approach, multinational firms can make it easier to manage FX risk
efficiently and thus, ensure their financial performance in the volatile global marketplace.
5.2 Centralized vs. decentralized risk management approach
The main parts of this program are the well-defined hedging policies and the robust governance
frameworks that, to be more precise, are the most essential parts of this program according to
Zuppiroli and Corsi (2020). These policies are the regulations that set the conditions of the tools
usage, the time of the tools use and the people who will be in charge of them. Besides,
governance frameworks perform the function of supervision and accountability when the process
of decision-making is going on with the assistance of the risk management committees and the
reviews (Abreu & Gulamhussen, 2013). Hedging policies are the guidelines that set the limits for
the management of FX risk, thus companies can set their risk management goals, choose the
right instruments for hedging, and establish the criteria for making the decisions. The policies
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likewise assign the responsibilities and duties of the main stakeholders which consequently, there
is no ambiguity and everybody is aware of the tasks to be performed in order to implement the
hedging strategies. The governance systems are the main base of the hedging operations which
ensure that the hedging activities are in accordance with the firm's goals and risk tolerance levels.
The risk management committees, which are a group of the representatives from the relevant
departments and the senior management, are the ones who manage the hedging policies, analyse
the risk exposures, and thus, recommend the changes if needed. The FX risk can be reduced by
the multinational companies through the hedging policies and the governance frameworks that
are well defined and reliable. Thus, they will be able to deal with the currency changes that are
unfavorable and their financial stability will be like the famous saying!The above mentioned
steps provide the necessary framework, clarity, and supervisions, which in turn make sure that
the FX risk management activities are in line with the firm's strategic goals and risk appetite,
thus, they are the ones that lead to the long-term value creation and sustainability.
5.3 Hedging policies and governance frameworks
The integration of risk management into the corporate strategy is the best way to make the FX
risk mitigation work perfectly as it is said by Aguilera-Caracuel et al. (2013). This type
necessitates the involvement of the senior management and the risk considerations that are
aligned with the whole strategic programs (Ahmed, Beatty, & Bettinghaus, 2004). The utmost
attainment of FX risk management efforts can be achieved through the alignment of these
endeavors with the aims of the firm which in turn facilitates the smooth integration of the
requirements to detect, evaluate and eliminate the currency related risks. The senior management
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is the main person who can make decision of the integration of technology into risk-awareness
decision-making and the resources allocation to the FX risk management projects. Conversely,
the incorporation of FX risk factors into the company's strategic planning processes can enable
the companies to find the chances to optimize their currency risks and to seize the positive
market situations. This bravo method not only reduces the chance of losing money from currency
changes but also enables the firms to use FX risk management as a strategic advantage that
makes them more adaptable and agile in the market volatility. Hence, the management of risks
becomes part of the corporate strategy of the firms, thereby they can improve their skills to
overcome the challenges of the global market, to achieve sustainable growth and to create the
long term value for the shareholders. Such the strategic alignment suggests the view of the whole
organization that FX risk management is a key part of the business strategy and not just an
isolated function. Hence, the companies are able to predict and conquer FX risk thus, in turn,
making the good decisions that will enable them to attain their strategic objectives and finally, be
successful in a world which is now more economically connected.
5.4 Integrating risk management into corporate strategy
By looking at the regulatory considerations, the FX risk management program is made more
robust with the fact that it guarantees the compliance and transparency, hence, Ellul, Wang, and
Zhang (2019) are proved. The adherence to the accounting rules and the rules of the government
that regulate the activities of the company, in turn, ensures the credibility and therefore, the
absence of the legal and reputational risks, while, at the same time, it facilitates the investor's
trust in the quality of the risk management of the company. By the meticulous treatment of these
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elements, multinational firms can establish risk management programs for the FX that will make
the financial situation of the company more stable and thus, they can deal with the market
uncertainties. Cease to be in accord with the regulatory standards of FX risk management means
to obey the laws that regulate the use of the derivative instruments, the reporting requirements,
and the capital adequacy requirements which is set by the supervising authorities, for example,
the Securities and Exchange Commission (SEC) and the International Financial Reporting
Standards (IFRS). Aside from that, the regulatory compliance is the one which will make the
firm's financial statements credible and limit the possibilities of the regulatory sanctions or the
legal disputes which will be initiated because of the non-compliance. Problems of transparency
in FX risk management procedures that causes the third parties to believe in the investor are the
main reasons for the preservation of the investor trust and the attraction of capital, particularly in
the global markets where investors demand the greater transparency and accountability from the
multinational corporations. The multinationals that adhere to the accounting standards and the
regulatory guidelines will be able to demonstrate that they are legitimate about the risk
management and hence they will be able to convince the stakeholders that the FX risks are being
handled properly. Hence, the firms can flexibly modify their FX risk management strategies as
the regulations change. Finally, the multinational firms will be able to safeguard themselves from
the market instability by including the regulatory requirements to their FX risk management
programs. Thus, the multinational firms will be able to strengthen their market resilience in the
face of market uncertainties and protect their financial stability in a global economy that is
becoming more and more regulated and connected.
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