Forex management may be defined as the science of management of generation, use and storage of foreign currencies in the process of exchange of one currency into other called exchange.
The above definition of Forex Management has the following essential elements:
A) It is part of management science:
Forex management is part of the broader management science. It is a scientific discipline requiring scientific and analytic orientation. The techniques of management are applied to the broad spectrum of foreign currencies. This broad spectrum refers to all the currencies of the world excluding the domestic currency. These techniques include planning for Forex, organization of Forex and control of Forex. We use the terms Forex and foreign exchange interchangeably. The planning part includes budgeting for Forex, organization refers to utilization of Forex and control part focuses on creation of Forex reserves.
The tools of Forex management are akin to domestic currency management but the level of analytical skills required for it is slightly higher because of the existence of spot, forward and futures markets unlike the domestic currency area. Operations in the Forex market require quicker response time because of the greater volatility in exchange rates.
B) It refers to generation of Forex:
Forex is generated from International Trade Transactions. When a company exports goods or services, it earns Forex. When goods or services are imported by a country, Forex is consumed. If he exports of a country are more than the imports, the Forex would be accumulated in reserves of the country. If the imports are more than the exports, the result would be Forex deficit which was to be met by international borrowings. Either way, the Forex needs to be generated. Generation of Forex is a more difficult proposition because of variation in international trade practices and extent of competition.
C) It pertains to use of Forex:
Forex management is concerned with the use of Forex in meeting the requirements of the user groups. The tools of cash management come handy in using Forex. The process of use of Forex involves identification of suppliers of goods and services, negotiation of terms and conditions of the transaction and culmination of transaction with the exchange of goods and services with Forex. Because of relative uncertainty about availability and volatility in its rates, advance tie-up of Forex is made through forward purchase contracts. In this entire process, close track of exchange rates needs to be maintained.
D) It covers storage of Forex:
Forex management involving firm level Forex storage could be done through forward purchase contracts or through deposits in foreign currency bank accounts. At the national level, Forex storage shortage is done through Forex reserves which are held in the form of Gold, Special Drawing Right (SDRs) of IMF and foreign currencies. While some amount of foreign exchange reserves need to be maintained to meet unforeseen contingencies, excessive accretion to reserves involve a cost which is sometimes justified on other economic consideration at the firm’s level. Forex is stored for meeting future import liabilities, whether certain of contingent. While storing Forex, it is important to bear in mind the actual cost of storage and opportunity cost of not using the Forex elsewhere. Depending upon availability of Forex, if the opportunity cost is more that the cost of storage, then it is better not to store it.