The importance of foreign exchange management for the survival and viability of the treasury function

Question

Discuss the importance of foreign exchange management for the survival and viability of the treasury function

Answer

Businesses with an international presence have to manage a series of risks of operating in a different country (Fetherston and Batten, 2002). This includes the prudent management of foreign currency exposure. While in the European union, many countries have the euro as their domestic currency, the rest of the countries of the world do not. Although under normal conditions a sudden fluctuation between two currency exchange rates is not likely, international businesses must implement various risk management techniques to limit their foreign currency risk exposure (Wachowicz and Van Horne, 2004). One of the most commonly applied practices is hedging, which is, in simple terms, a contract between two parties to use a given currency at a predetermined exchange rate, so that any fluctuation in the exchange rate cannot affect the business relationship.

Commercial banks’ treasury function includes all activities which are necessary to manage the bank’s liquidity and to mitigate financial risk, including but not limited to risk of recording assets (and liabilities) in a foreign currency (Fetherston and Batten, 2002). If banks do not consider the risk associated with using a foreign currency, the effects of any sudden movement can be devastating. Financial statements and any other documents stakeholders use to receive factual information can be distorted if banks do not manage their foreign currency risk.

References

Fetherston, T. and Batten, J. (eds.) (2002) Financial risk and financial risk management. Amsterdam: Emerald Group Pub Ltd, New Milford, Connecticut, U.S.A.

Wachowicz, J. M. and Van Horne, J. C. (2004) Fundamentals of financial management. Harlow, England: Financial Times/ Prentice Hall.