This paper reviews the literature on Foreign Exchange Risk Management (FERM) which has burgeoned during the last decade. Scholars' and practioners' emerging interest in Foreign Exchange Risk Management was spurred by the advent of fluctuating exchange rates in the early seventies as well as by the pronouncement of the infamous FASB Statement No. 8 in 1976 which laid down unambiguous guidelines for consolidating financial statements of multinational corporations. A normative (rather than a market) view of Foreign Exchange Risk Management is taken and accordingly the author reviews first the two key informational inputs necessary for any Foreign Exchange Risk Management program: forecasting exchange rates and measuring exposure to exchange risk. Available decision models for handling transaction and translation exposures are reviewed next. A concluding section identifies gaps in the existing literature and suggests directions for future research.

https://link.springer.com/content/pdf/10.1057%2Fpalgrave.jibs.8490572.pdf

Management of Foreign Exchange Risk: A Review Article

Dr. Shapiro is an Assistant Professor at The Wharton School of the University of Pennsylvania. He has published a number of articles related to international financial management and is a consultant for several banks and multinational corporations in this area. Dr. Rutenberg is an Associate Professor of Industrial Administration at Carnegie-Mellon University. He is completing a book Multinational Tactics which brings together his research in multinational finance, production, and marketing. Rutenberg has been a consultant to numerous corporations on questions of strategy and competition.

http://www.jstor.org/stable/pdfplus/3665180.pdf

Managing Exchange Risks in a Floating World

This paper reviews recent developments in models dealing with capital structure and cost of capital for the multinational firm. A number of issues which bear upon the financing decisions of the multinational corporation are addressed, and related to underlying theoretical and empirical questions with regard to the degree of segmentation or integration of international money and capital markets and the efficiency of the foreign exchange market. Data problems, areas of conflict, and topics for future research are identified. The paper concludes with a summary of financial policy prescribed for the firm by the present state of knowledge.

https://link.springer.com/content/pdf/10.1057%2Fpalgrave.jibs.8490573.pdf

Capital Structure and Cost-of-Capital for the Multinational Firm

The treasurer of a multi-national corporation can hedge to protect his corporation against an impending currency devaluation or revaluation. He can cover a future period, τ, now, without covering any intervening periods, by selling the suspect currency forward for τ periods and buying it forward for τ-1 periods. There are generally no external economies resulting from hedging for more than one period at a time so that the problem is formulated to analyze each period separately. The cost of hedging for corporate sized amounts appears to be linear so the hedging price for each period is treated as a constant. Given current costs, expectations of costs, and expectations of probable devaluations or revaluations, should the treasurer now contract to hedge a particular period or should he wait? The aggregation of the past and current hedge decisions constitutes the intervals to be hedged now. Each of these hedge or wait decisions is formulated as a dynamic program. This dynamic program fortunately distills down to a very simple decision rule of comparing the expected cost of hedging with a constant for that period when unhedging is permitted. Even when the spread between the buying and selling rates is significant, there will be a need to solve numerically a dynamic program for only a few of the periods. We present and analyse four situations: 
Hedging with no unhedging.
Hedging with the option of unhedging later, but with a spread between buying and selling costs.
Hedging in the face of a key event that will branch the probabilities.
Hedging when there's a chance of more than one devaluation.

When to Hedge Against Devaluation

One of the factors which complicates financial decision making in a multinational enterprise is currency devaluations or revaluations in countries where subsidiaries are located. Since exchange rate changes affect the reported earnings, value of financial assets, and future earnings of the multinational corporation, it is imperative that the financial decision maker of such a firm develop a strategy to manage the foreign exchange risk assumed by the firm. It is the purpose of this article to develop relatively formal decision rules for managing the risk of exchange rate change. These rules are based on an analysis of a theoretical decision model of the exchange management process. The inherent uncertainty involved in exchange rate movements is the basic feature of the exchange risk situation. The nature of an optimal decision thus will depend on the attitudes of management toward risk and uncertainty. Four common attitudes will be assumed and examined: minimum variance, minimax, expected monetary value, and expected utility. Each yields a particular set of optimal rules for exchange risk adjustment. Three techniques are available for adjusting the exchange risk posture of the firm. These are (1) adjustment of funds flows, (2) forward contracts, and (3) exposure netting. Adjustment-of-funds-flow techniques involve an alteration in the planned funds flows of parent and/or subsidiaries, in amount and/or currency of denomination, with the view of reducing (or increasing) the local currency accounting exposure of the corporation. This exposure is defined as the difference in local currency assets translated to domestic currency at the current exchange rate and local currency liabilities translated at the same exchange rate. If the objective of management is to decrease exposure, the technique must increase local currency denominated liabilities or decrease local currency denominated assets. Techniques for increasing liabilities include local borrowing and stretching payables. Techniques for decreasing assets include reduction of cash balances and other liquid assets, reduction in investment in accounts receivable (either by tightening credit terms or factoring), and reduction in inventory investment (if inventories are translated at the current exchange rate). Each of these techniques generates local currency funds. If exposure is to be reduced, these funds must be used to acquire assets which are not exposed to the exchange risk. For example, if the parent corporation had planned to provide domestic currency funds to the subsidiary, locally generated funds can replace funds from the parent. Alternatively,

Decision analysis for exchange risk management

The basic model of this paper is that of a transactor who is to receive at a specified time t in the future a fixed quantity of domestic funds A d and a fixed quantity of foreign funds A f . It is further assumed that there exists a forward market in foreign exchange in which one unit of foreign currency can be bought and sold at a given and known forward rate r f , the domestic currency price of one unit of foreign currency. Let X be the net forward purchases of foreign exchange that the transactor undertakes at the market rate r f ; a negative value of X indicates net sales of forward exchange. It is assumed that at time t the foreign currency will be convertible for the transactor at a fixed but unknown spot exchange rate and that the transactor can assess or derive a probability distribution on this spot exchange rate f(r t ) for r t > 0. Finally, it is assumed that the transactor can express a utility function u on the domestic currency equivalent of his ending currency holdings. This paper considers the problem of determining the optimal level of forward exchange purchases X 0 .

William R. Folks

Papers

The Optimal Level of Forward Exchange Transactions

Optimal Foreign Borrowing Strategies with Operations in Forward Exchange Markets