Accounting technology / Glossary / FX risk management

What is FX risk management?

Definition

FX risk management is how a company identifies and controls the effect of exchange rate movements on its cash flows, profits and balance sheet. It measures exposures from foreign currency sales, purchases, cash and loans, sets a hedging policy, and reduces risk through natural offsets, netting and hedging contracts such as forwards, swaps and options.

Also calledforeign exchange risk managementcurrency risk managementFX hedging

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Exposure types: Transaction, translation, economic
Common tools: Forwards, swaps, options
Hedge accounting: IFRS 9 / ASC 815

How FX risk management works

There are three main kinds of exposure. Transaction exposure arises from invoices, payments and forecast cash flows in foreign currencies. Translation exposure arises when foreign subsidiaries' results are converted into the group's currency for reporting. Economic exposure is the longer-term effect of rates on competitiveness. Treasury collects exposures from the ERP, forecasts, bank balances and intercompany loans, nets offsetting positions, and hedges the rest under a policy that sets which exposures to cover and how far ahead. Forwards fix a rate for a future date; options cap the downside for a premium. Hedge accounting under IFRS 9 or ASC 815 can match hedge gains and losses with the hedged item, but requires documentation and effectiveness testing. Embat consolidates FX exposures from the ERP, forecasts and bank balances and flags breaches of hedging limits.

Common questions

What is the difference between transaction and translation exposure?+

Transaction exposure affects actual cash flows from foreign currency deals. Translation exposure affects reported figures when foreign subsidiaries' accounts are converted into the group currency.

What is a natural hedge?+

Matching revenue and costs, or assets and debts, in the same currency so movements offset without a hedging contract, for example paying local suppliers from local sales.

What is hedge accounting?+

An optional treatment under IFRS 9 and ASC 815 that records gains and losses on hedging instruments in the same period as the item hedged, reducing profit volatility, subject to documentation and effectiveness rules.