International Trade and Finance: A North American Perspective

By Khosrow Fatemi | Go to book overview

V
CURRENCY MARKETS AND RISK MANAGEMENT

The volatility of the currency markets in recent years has made risk management an important part of international financial management. Not only have there been long-term trends of different currencies appreciating or depreciating by substantial margins, but also short-term volatility of several percentage points up or down in a few days. All of these changes have made forecasting foreign exchange rate fluctuations a necessary (albeit seemingly impossible) function of any multinational company with financial commitments in other currencies. This volatility has also led to the development of several hedging and forecasting techniques, two of which are discussed in Part Five.

In Chapter 9, Charles E. Hegji, Keivan Deravi, and Philip Gregorowicz discuss the general topic of the use of information by the participants of currency markets in establishing currency rates. Their model, using the 1975-1985 period, is a test of short-run response of the currency markets to government announcements. Specifically their study analyzes the response of several major foreign currencies to the Treasury Department's announcement of its quarterly funding operations, and to alternative measures of real economic activity. They conclude that prior to 1982, exchange rates responded significantly only to information about real economic activity. In contrast, beginning with the period of growth of federal deficits in 1982, only the market's response to the Treasury's announcement is significant. The authors also reach the conclusion that the dollar depreciated with the receipt of new information during the earlier period, but appreciated in response to information over the latter period.

In Chapter 10, Joseph F. Singer and Ray D. Siehndel provide an extensive discussion of the mechanics of options trading and the use of options as a technique of risk management. Their discussion of the activities and strategies of the options market is followed by a demonstration of how options strategies can be used to protect investments denominated in foreign currencies against adverse currency fluctuations. They maintain that the versatility of options trading has led to the general view that options are purely speculative instruments. They argue, however, that options can also provide means of hedging both commercial and financial exposure, including currency fluctuations.

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