Currency exchange rate is one of the important factor which affect external and internal balances of a country. Devaluation of a local currency makes its goods relatively cheaper. So its capacity of exports is likely to increase with devaluation if it has got enhanced productive capability and favorable trade-related elasticity. With the increase in demand for country’s goods and services, its currency appreciates and reverse is the case if its volume of exports falls. So Cristine (1981) describes the foreign exchange risk is the possibility of changes in the value of the company which arises from the potential for changes in foreign exchange rate. When a developing country like Pakistan is dependent on imports even to meet its demand for machinery, their parts and other goods for its local industries, then the devaluation becomes a curse.
Siddiqui (2009) describes that Pakistan where economic, political and financial institutions are yet to be strengthened and administrative structure is needed to be disciplined. Pakistan is experiencing the most terrible politico-economic crises in its history. This crisis is adversely affecting its local currency in addition to other monetary and real variables. Pakistan’s exchange rate which changes more frequently than the tradable goods and services with trade related low frequency variables such as exports and imports. The economy of Pakistan is experiencing slowdown in inflows relative to outflows of currency exchange.
The foreign exchange risk appears in the situation when, on the payment day, the transaction currency has a buying power higher than in the moment of concluding the contract. Companies are managing this risk by entering into foreign currency derivatives such as foreign currency forwards, futures and swaps (Wilson, 2002).The increase worldwide business activity has increased the foreign currency exposure of many companies. The globalization of the economic life, the competition among nations for an increasing proportion in the international trade. Due to this competition the dramatic structural changes in the commodities production and distribution systems and also in the management, on the background of turbulences in the financial markets, represent factors of risk and also managerial challenges.
The deepening of globalization process has led to an increase in currency exchange dealings in international financial markets. Also, multinational firms with operations in some countries will have translation risks from having assets and liabilities denominated in foreign currencies (Bradley and Moles, 2002). This has determined a higher volatility of exchange rates, and, implicitly, an increased currency exchange risk. There are many types of risks, but only some of them can bring losses as large as foreign exchange risk. Firms involved in international trade are subject to transaction risk occurring from payables and receivables in foreign currencies. In these conditions, the...