Exchange risk is potential loss or gain due to change in currency rates. In other words, it's is the effect of unanticipated currency movements on cash flows, assets, liabilities and on the overall business of the firm. Risk is risk because it is unanticipated. Let's take an example from recent times - fall and rise of Indian Rupee. Companies with Dollar liabilities were sitting pretty as rupee remained stable to strong for some time. When the local currency started its downward spiral, there was panic and mayhem; and lo, rupee is recovering and we still wonder what has changed fundamentally . Nonetheless, rupee's move has left companies scampering for cover!
Markets are (and will continue to be) what they are. They move and up and down, taking anyone caught in its way, along. The question is, should firms actively manage their risk? Lack of understanding of risk management tools, ability to measure exposure and risk, perceived high transaction costs for hedging and such kept corporates from undertaking hedging. Then came a slew of banks "educating" customers in derivatives and the rest is history! Once bitten firms shied further away from markets and risk management. However markets keep challenging the "do nothing" strategy of firms and (sooner or later) they are left with no choice but to prioritize market risk management.
Indian companies (irrespective of size) are increasingly open to spend time and effort to manage market risk; this is certainly good news.
In my experience of working with corporates, one common lacuna to effective risk management is lack of timely exposure recognition. The first step to manage market risk (or any risk) is to acknowledge (timely) that such exposure/s and risk/s exist/s. Do I mean MIS (Management Information System)? Does it sound mundane and obvious? Do they all have information system in place? Of course they do! Does it reflect business like it is? We all know the answer. A CEO tells me that their firm has an annual export turnover of USD 200 million; I call for an exposure summary and it gives me totally different and understated picture. Sounds familiar? How does one plan and take decisions, when basic data is incomplete / inadequate?
What is a complete MIS, you ask? Let's take an example of a report used by your treasury team to manage market risks. Is it up-to-date? (has export sale concluded this morning flown in? has the delayed shipment detail been amended?), Is it detailed? (Does it contain exchange rate at the time of exposure origination, payment terms, expected date of inflow, etc?), is it comprehensive (does it cover bulk orders and shipment schedule of your regular buyers?), can it be queried for monthly nett (of exports/imports and PCFC) exposures? In short, with a click of a button, could you get a complete picture of your exposure - gross/nett, hedged / open, budget vs mark to market? See what I'm saying?
Want to manage your market risk, start with sound MIS!