Managing foreign exchange risk is a four-step process, as illustrated in Figure 2.

Develop Your
Companys FX Policy 2
Source: EDC Corporate Research Department
Identify and Measure
FX Exposure 1 Hedge Exposure using Trades
and/or Other Techniques 3 Evaluate and Adjust
Periodically 4
Figure 2: Steps in the Management of Foreign Exchange Risk
EDC | Managing Foreign Exchange Risk 5
Step one involves identifying and measuring the foreign exchange exposures that
you want
to manage. As mentioned earlier, the focus for most companies is on transaction
risk. For
an exporting company paid in U.S. dollars, measuring exposure involves subtracting
the
U.S. dollars it expects to receive over a one year period, for example, against the
money it
will need in order to make payments in U.S. dollars over the same period. The
difference
determines the exposure to be hedged. If your company already has U.S. dollars in
the bank,
subtract the account balance to determine the net exposure. Some companies only
include
confirmed transactions while others include both confirmed and forecasted foreign
currency
cash flows over the designated time period.
To Hedge or Not to Hedge?
Many Canadian companies, particularly smaller and medium-sized ones, do not
actively

manage foreign exchange risk. This is surprising given how costly, in terms of cash
flow and
profitability, unfavourable changes in the value of the Canadian dollar can be. As
Figure 3
below shows, changes of more than 5% in the value of the Canadian dollar relative
to the
U.S. dollar are commonplace over a 60 day period.
Such variations in exchange rates
directly impact the profit margins
of Canadian companies that export
(and receive U.S. dollars) or that
import (and need to make payments
in U.S. dollars). For instance, if
a Canadian exporter sells to a
U.S. buyer component parts, for
US$300,000, and has based its price
on a USD/CAD exchange rate of
0.9375, then this means that it expects
to receive CAD$320,000. If, at the
time it receives the US$300,000
payment, the Canadian dollar
is now worth 0.9920USD/CAD
(equivalent to a 5.8% increase in value in the Canadian dollar), then the company
will only
receive CAD302,419. This represents CAD$17,581 less Canadian dollars than
expected.
Once you have calculated your exposure, you need to develop your companys
foreign

exchange policy as part of step two. This policy should be endorsed by the
companys
senior management and usually provides detailed answers to questions such as:
When should foreign exchange exposure be hedged?
What tools and instruments can be used under what circumstances?
Who is responsible for managing foreign exchange exposure?
How will the performance of the companys hedging actions be measured?
What are the regular reporting requirements? January 05 July 05 January 06 July
06 January 07 July 07 January 08 July 08 January 09 July 09
January 10
Source: Bank of Canada and EDC Corporate Research Department
Figure 3: Percentage Change in the Value of the CAD Against the USD
Over Rolling 60 Day Periods January 2005 to January 2010
-25%
-20%
-15%
-10%
0%
-5%
5%
10%
15%
EDC | Managing Foreign Exchange Risk 6
The question of when to hedge is interesting. As Figure 4 illustrates, transaction
exposure can
begin much earlier than accounting exposure. As well, pre-transaction exposure
cannot be ignored

as selling prices, once quoted, can rarely be changed in todays global marketplace.
Therefore
you must carefully assess when to start hedging your exposure.
Step three involves putting in place hedges that are consistent with your companys
policy.
For example, you may want to increase the value of raw materials imported from
the U.S. to
partly offset the exposure created by sales to U.S. buyers. Alternatively, you may
put in place
basic financial hedges with a bank or foreign exchange broker. The most commonly
used
financial hedges are discussed further below.
Step four requires that you periodically measure whether the hedges are effectively
reducing
your companys exposure. Establishing clear objectives and benchmarks will help
facilitate
this evaluation. It will also alleviate the fear of those responsible for implementing
the policy
that they have somehow failed if the exchange rate moves in the companys favour
and the
hedges they put in place prevent the company from benefiting from that move.

Methods of managing foreign exchange risk

Having identified and measured the potential exposure, the next problem is to
manage it. There are many methods for this, but before selecting one, the business
should determine the risk appetite of its key stakeholders such as directors.This will
help to determine which method would be the most appropriate. Guidance in this
regard can be found in the CPA Australia publication, Guide for managing financial
risk.These are the main methods:

Forward exchange contract: This enables the business to protect itself from
adverse movements in exchange rates by locking in an agreed exchange rate until
an agreed date. The transaction is deliverable on the agreed date. The problem with
this method is that the business is locked into the contract price, even when there

at movement is advantageous to it. For example, if a business purchasing capital

equipment wanted certainty in terms of the local currency costs, it would buy US
dollars (and sell local currency) at the time the contract was signed, with a forward
rate agreement. This would lock in the local currency cost, ensuring that the cost
paid for the equipment will equal the original cost used to determine the internal
rate of return of the project.

Foreign currency options: These enable an entity to purchase or sell foreign

currency under an agreement that allows for the right but not the obligation to
undertake the transaction at an agreed future date. For example, if an importer is
importing goods denominated in US dollars for delivery in three months and enters
an agreement with their bank for a forward exchange contract, then the importer is
contractually bound to accept the USDs they have purchased at the agreed rate (for
local currency) on the agreed date. If the local currency strengthens against the US
dollar then the importer must still honour the contract even if the agreed rate is less
favourable than the current exchange rate. If the importer enters into a foreign
currency option transaction, then for the price of a premium, the option will protect
the importer from downward movements in the value of the local currency against
the other currency, but allow the importer to benefit from increases in the local
currency against the other currency.If, for example, the local currency increases in
value, the importer can abandon the option (and use the spot price of the currency
instead). If the domestic currency decreases in value, the importer can rely on the
rate in the option to purchase the goods. The maximum cost to the importer is the
premium. An exporter would enter into a foreign currency option that would protect
it from upward movements in local currency and get the benefit of downward
movements in the local currency by abandoning the option and using the spot price
of the currency. Essentially, a foreign currency option is like insuring against adverse
movements in exchange rates. A premium (which can be relatively expensive) to
undertake this transaction is usually required. There are a number of different types
of options that can be used to manage foreign exchange risk.

Perfect hedge: A simple method is to match any outgoing foreign currency

payments against foreign currency inflows received at exactly the same time. This
method is rarely used due to the uncertainty of timing of the cash flows. The inflow
and the outflow must occur at exactly the same time to provide a perfect hedge.

Foreign currency bank accounts / loan facilities:These alternative methods of

managing foreign exchange risk can be used when the timing of the foreign
currency inflows and outflows dont match. The timing issues can be managed by
depositing surplus foreign currency in a foreign currency account for later use, or by
borrowing foreign currency to pay for foreign currency purchases, and then using
the foreign currency to repay the loan.
Effects of Migration:

The effects of labour mobility (migration) can be studied in the following two
categories:
Positive Effects of Migration:
1. Wage Effect:
Labourers usually migrate from low wage countries to higher wage nations. Such
movement of labour leads to changes in wages in both countries unless it is
prevented
or guarded by law.

2. Effect on Skilled and Unskilled labour:

Countries where there are shortages of skilled and unskilled labour will benefit when
there is movement of labour from other country to that country. Labour can be
productively employed who can contribute to economic development in a positive
manner.

3. Effect on Unemployment:
Emigration enables some countries to relieve their excess manpower and
unemployment. The emigrant labour force forms a significant portion of the total
labour
force of several countries. In some of the European countries, emigrations helped to
reduce employment demand which otherwise could not have absorbed domestically.

4. Remittance:
Emigrant remits a part of their income back to the native country for their families.
It
helps the home country to reduce their balance of payment problem and increase
investment at home, import capital goods and promote development of the home
country. Remittance from developed and developing economies with higher levels of

per capita income, have become an increasingly important source of external

development finance. Remittance rose steadily in the 1990s, reaching more
than$60
billion in 2001.

Negative Effects of Migration:

1. Brain Drain:
Flight of human capital, more commonly referred to as brain drain. It is the largescale
emigration of a large group of individuals with technical skills or knowledge. The
reasons usually include two aspects which respectively come from countries and
individuals.
In terms of countries, the reasons may be social environment (in source
countries: lack of opportunities, political instability, economic depression, health
risks,
etc.; in host countries: rich opportunities, political stability and freedom, developed
economy, better living conditions, etc.).
In terms of individual reasons, there are family influences (overseas relatives),
and personal preference: preference for exploring, ambition for an improved career,
etc.
Brain drain is often associated with de-skilling of emigrants in their country of
destination, while the country of emigration experiences the draining of skilled
individuals
2. Illegal immigrants:
It is a serious problem in many countries India, USA, and Canada. It may take place
due to political, economic, social and religious factors. Changes in the ethnic
composition of the population can have socio-political repercussions. It can create
social tensions.

3. Problem of social integration:

Immigrants belong to different countries, religion, race, colour, culture. Social
assimilation with the people of host countries becomes difficult in the initial stages
due
to colour, religion and cultural difference. At times ethnic and religious differences
create a problem for the host country as it happens in UK and India.

4. Fiscal imbalance:
When immigrants constitute in large numbers, the host country requires spending
huge
amount of capital to provide the required economic and social infrastructure. As
some
immigrants settle down permanently, the government as to spend greater amount
on
social security benefits. Expenditure on all these counts may create fiscal imbalance
in
the form of increase budgetary deficit.

Trends of labour migration

The nationality composition of the immigrant population in several countries have
changed due to the introduction of systematic regulation of immigration to suit the
manpower requirement of the host countries along with the differences in the
supply
response of various emigrant countries.
Regulation and changes in the nationality composition: Countries like United
States, Canada and Australia which had previously favoured immigrants from
Europe
and discriminated immigrants particularly from Asia introduced changes in their

immigration legislation which shifted the emphasis away from the national origin of
the
immigrants to the skills which the potential immigrant possess. These changes
occurred
partly as a response to various pressures against racial or national origin
discrimination,
and partly because of the need for well defined industrial and professional skills and
the
disappearance of traditional European sources of skilled workers. The changes in
the
immigration policy of the developed countries which opened up large avenues of
emigration from the developing countries have resulted in a brain drain from these
countries.
Similarly, there has remarkable change in the nationality of the population in the
Middle East countries as well. The non- Arab countries in the Middle East came from
countries like Pakistan, India, Bangladesh, Philippines and Korea, counter to the
general tendency to attract workers from immediately neighbouring and culturally
more
similar countries.
Factors Affecting Changes in Composition:
The change nationality composition of the migrant workers was due to the
inability of the Arab labour exporters to meet the growing demand of labour which
increased the scope for participation by non- Arabs in the labour markets of the oil
rich
countries . The increase in the immigrants of the Asian workers was encouraged by
their willingness to accept job and living conditions and wages that Arabs resisted.
The
Gulf countries had an apprehension that Arab migrants may bring unwelcome
political

ideologies and cleavage that characterize other countries in the region. Contrary to
this
Asian workers are seen as outsiders and as apolitical. They are expected not to
interact
with the local population, are less likely to stay permanently and they can be
expelled
with less political repercussion.
Composition of Migratory Population in Developed Countries:
Until the early1960s, about 80 of the immigrants in United States, Canada,
and Australia came from the other industrial counties and the remaining coming
from
the developing economies. But by 1980s, the trend reversed with 80 percent of the
immigrants in US came from the developing economies which accounted for nearly
a
quarter of the increase in population of which half of it came from Asia. Similarly
there
has been a rising share of immigrants from the developing countries to Canada,
Australia and Europe. The aspiration for migration from the developing countries to
developed countries will be stronger as the population rate of the developing
countries
has been falling while that of the developing economies has been on the rise.
The number of people migrating to some of the OEDC was on rise in the year
2003, 2004 and 2005 from 29,94,700 people to 47,68,300 people but from the year
2008 there had been a decline in immigrants to these countries mainly because of
the
Euro crisis, earth quakes and tsunami in Japan and slow economic recovery of US.
The
immigrants to the gulf countries also reduced due to the Arab Spring which is
spreading
in gulf countries which has reduced the employment opportunities of the
immigrants.

Moreover, the change in the policy of the gulf countries to employ first the local
people
has reduced the employment opportunities to the migrants in these countries.
In the recent years, movement of people from one country to another has
restricted due to the fear of terrorism. In the long run as the developing counties
develop and quality of life improves, the rate of migration will tend to decrease.

Changing role of imf

Since the onset of the global economic crisis in 2007, The IMF introduced several
changes in its lending reforms, policy of lending aid to poor countries, governance
reforms, conditionalitys of getting funds etc. which are as follows:

Governance Reform:

On December 15, 2010, the Board of Governors approved far-reaching governance

reforms under the 14th General Review of Quotas. The package includes a doubling
of quotas, which will result in more than a 6 percentage point shift in quota share to
dynamic emerging market and developing countries while protecting the voting
shares
of the poorest member countries. The reform will also lead to a more
representative,
fully-elected Executive Board. Changes in Conditionality of Fund: The conditionality
of
IMF are no longer set in quantitative targets such as reducing fiscal expenditure, or
contracting the supply of credit to bring aggregate demand in balance with the
aggregate supply. The conditionalitys are now set in qualitative targets such as
structural reforms, passing of new legislations such as bankruptcy codes, reform of
tax
administration and removing rigidities that hold back growth.

Credit line for strong performers:

The Flexible Credit Line (FCL), introduced in April 2009 and further enhanced in
August
2010, is a lending tool for countries with very strong fundamentals that provides
large
and upfront access to IMF resources, as a form of insurance for crisis prevention.
There
are no policy conditions to be met once a country has been approved for the credit
line.
Colombia, Mexico, and Poland have been provided combined access of over
$100 billion under the FCL (no drawings have been made under these
arrangements).
FCL use has lead to lower borrowing costs and increased room for policy scheme.
Structural performance criteria have been discontinued for all IMF loans, including
for
programs with low-income countries. Structural reforms will continue to be part of
IMFsupported
programs, but have become more focused on areas critical to a countrys
recovery.

Social Safety Net Programs:

The IMF is promoting measures to increase spending on, and improve the targeting
of,
social safety net programs that can mitigate the impact of the crisis on the most
vulnerable in society.
Reforms in the Lending Framework of the IMF:
To provide better support to countries during the global economic crisis, the IMF
beefed

up its lending capacity and approved a major overhaul of how it lends money by
offering
higher amounts and tailoring loan terms to countries varying strengths and
circumstances.

Policies for Low Income Countries:

In response to the global financial crisis, the IMF undertook policy reforms toward
lowincome
countries. As a result, IMF programs are now more flexible and modified to the
individual needs of low-income countries, with streamlined conditionality, higher
concessions and more emphasis on safeguarding social spending.

Availability of Resources:

Resources available to low-income countries through the Poverty Reduction and

Growth Trust over the period 20092014 were boosted to $17 billion, consistent with
the
call by G-20 leaders in April 2009 of doubling the IMFs concessional lending
capacity
and providing $6 billion additional concessional financing over the next two to three
years. The IMFs concessional lending to low-income countries amounted to $3.8
billion
in 2009, an increase of about four times the historical levels. In 2010 and 2011,
concessional lending reached $1.8 billion and $1.9 billion respectively.
Establishment of a Post-Catastrophe Debt Relief (PCDR) Trust:
This allows the IMF to join international debt relief efforts for very poor countries
that are
hit by the most catastrophic of natural disasters. PCDR-financed debt relief
amounted to
$268 million in 2010.

Efforts against Global Crisis:

As a key part of efforts to overcome the global financial crisis, the Group of Twenty
industrialized and emerging market economies (G-20) agreed in April 2009 to
increase
borrowed resources available to the IMF (complementing its quota resources) by up
to
$500 billion (which tripled the total pre-crisis lending resources of about $250
billion) to
support growth in emerging market and developing countries. In April 2010, the
Executive Board adopted a proposal on an expanded and more flexible New
Arrangements to Borrow (NAB), by which the NAB was expanded to about
SDR 367.5 billion (about $560 billion), with the addition of 13 new participating
countries
and institutions, including a number of emerging market countries that made
significant
contributions to this large expansion. On November 15, 2011, the National Bank of
Poland joined the NAB as a new participant, bringing the total to about SDR 370
billion
(about $570 billion) and the number of new participants to 14 (once all new
participants
have joined). In addition to increasing the Funds own lending capacity, in 2009, the
membership agreed to make a general allocation of SDRs equivalent to $250 billion,
resulting in a near ten-fold increase in SDRs. This represents a significant increase in
own reserves for many countries, including low-income countries.

Sharpening of IMF Analysis and Policy Advice:

To try and prevent future crises, the IMF is working closely with governments and
other

international institutions. Risk analysis has been enhanced, including by taking a

crosscountry
perspective, and early warning exercises are being carried out jointly with the
Financial Stability Board. Analyses on linkages between the real economy, the
financial
sector, and external stability are being strengthened. Work has also been done on
mapping and understanding the implication of rising financial and trade
interconnectedness for surveillance and for lending to strengthen the global
financial
safety net.