ROLE AND IMPACT OF CURRENCY DERIVATIVES IN MANAGING FOREIGN EXCHANGE RISKS AND THEIR REGULATORY FRAMEWORK

Abstract

A Multinational company with high currency risk is likely to face financial difficulties which tend to have a disrupting on the operating side of the business. A disrupted financial condition is likely to Result in the problem of adverse incentives and weakens the commitment of various stake holders. Foreign exchange exposure and risk are important concept in the study of international finance. It is the sensitivity of the home currency value of asset, liabilities, or operating incomes to unanticipated changes in the exchange rates. Exposure exists if the home currency values on an average in a particular manner. It also exists where numerous currencies are involved. Foreign exchange risk is the variance of the home currency value of items arising on account of unanticipated changes in the exchange rates. The derivative instruments like forwards, futures and options are used to hedge against the foreign exchange risk of the Multinational companies. The original derivatives contract of International Finance is the ‘Forward exchange contract’. Forward Foreign exchange is a traditional and popular risk management tool to obtain protection against adverse exchange rate movements. The exchange rate is ‘locked in’ for a specific date in future, which enables the person involved in the contract to plan for and budget the business expenses with more certainty. Forward exchange market, has since the 1960s, played the role of linking international interest rates. Today, however, Forward contract have to share other instruments and markets for arbitrage and for hedging. These newer derivative instruments include Futures, Options and Swaps.