Treasury and Risk Management in an International Context Assignment

Treasury and Risk Management in an International Context - Assignment Example Exchange rate system shows the arrangement in which an authority controls value of different currencies in foreign exchange market with respect to other currencies. There are mainly two types of exchange rate systems such as fixed and floating exchange rates. Fixed exchange rate system aims to fix the value of a currency against the value of a stronger currency, a basket of currencies or other measurements like gold. The system is better known as pegged exchange rate because it triggers to stabilize the value of a currency through pegging it with a steadier and internationally recognized currency. Hence, trading opportunities become more stabilized and predictable, especially for economies in which external trade is held responsible for a large chunk of Gross Domestic Product (Ghosh, A, M. G. Wolf and H. C. Wolf, 2002). Though, according to the theory, fixed exchange rate leads to establish greater economic stability and helps the multinational firms to forecast future currency rates so that risks associated with international pricing can be managed by them, in reality, devaluation or revaluation of currencies driven by inflation, interest rate, and other economic variables do not allow currencies to remain fixed forever (Caves, 2007). Hence, the policymakers have adopted a resolution of fixing currency with a portfolio of a number of currencies with different weights such as euro, yen, British pound etc. This type of exchange rate is less susceptible to the economic occurrences of a particular country. For instance, increase in inflation rate will directly impact on a currency pegged with US dollar; however, if the currency is pegged with a basket of currencies, the effect of increasing inflation in the US will be diluted by the presence of other currencies and will have less impact on the pegged currency.