The International Guide of Foreign Currency Managementby Shoup Research Paper

The International Guide of Foreign Currency Managementby Shoup - Research Paper Example (Goldstein, 1992) Currency and its management determine the economical footing of the State and as such must be strictly controlled by the Government. Strength and value of a States currency is affected by several contributing factors. These factors may be intentionally implemented or developed as a result of external impact. This was seen in South Africa in the 1980’s when the price of Gold had significantly fallen in addition to other financial challenges faced by the government during the same period. As a result what was seen in South Africa was a drastic devaluation of the Rand in comparison to the American dollar. (Murison 2003) South Africa never fully recovered from the devaluation of the Country’s currency. Currency management operates on three basic tenets according to JP Morgan’s â€Å"Active Currency Management for Institutional Investors†. These are; market dynamics which refer to the foreign exchange market where it is inefficient and offers potential alpha due to the high proportion of non-profit seeking participants. Secondly there is consistent return which requires active currency managers who are able to generate consistent and modest returns throughout the market cycles. Finally there is diversification which refers to the returns of active currency managers who are not highly correlated with traditional asset classes. JP Morgan in Passive Currency Management (2011) identifies three ideal steps at the strategic level for passive currency management. Firstly, there is the need for the modelling of the foreign currency plan based on the risks identified in each business and determining a hedge ratio for the sensitive areas. Secondly, there is the need to cover the exposures of the assets through the use of various hedging techniques that are appropriate in the situation. Thirdly, there is the need to execute and monitor the plan with regards to transaction costs. JP Morgan emphasised that the most popular hedging te chnique for passive currency management is the use of forward currency contracts. Fabozzi (2008) assesses passive currency management techniques and identifies three main elements of this currency risk management approach. First of all, the management takes a standard currency hedging and roll it over through the life of an investment. Secondly, it is not flexible and cannot be changed even if external conditions change. Thirdly passive currency risk management involves the continuous conversion of the home currency to a given currency on a frequent basis. Currency risk exposure was later categorized into three groups by Zubulake, 1991who sought to determine preventative measures. These are; the translation which refers to the uncertainty of converting foreign denominated assets to local currency. Where there is uncertainty on the foreign market then the stability of the currency is threatened since sectors such as banking and real estate remains stagnated. The second category of ri sk exposure is that of transactional risk which detail the effects of fluctuations in exchange rates on revenues, expenses and profitability. Risky transactions have the potential to restrict the spending and trading ability of the population. Spending and trading being two of the main means of currency circulation will significantly impact on the Country’s economy when restricted. Thirdly, there is the economic exposure currency risks which assess the effects of fluctuations in a Country's currency over the long-term macro economics of the country, namely, prices, competition and export. As such, measures must be implemented to ensure that where there is exposure the