Essentially, all manipulations of exchange rates and actions based on predictions of exchange rates are focused on the forward exchange rate, or the predicted rate of exchange between two currencies at a future point in time.
The spot exchange rate, on the other hand, is the rate of exchange at the current moment in time. It is through a comparison of the spot rate and the forward rate of exchange -- inasmuch as it can be predicted with any accuracy -- that companies and businesses make decisions that affect either the exchange rate itself (in the case of some governments, notably China in the modern period), or more often make decisions that limit their exposure to foreign exchange rate volatilities and risks.
In the context of treasury management, stabilization of the domestic currency value is also of importance in maintaining investor confidence both in domestic and international investors, and although direct currency manipulations are generally frowned upon efforts are taken to maintain a positive and relatively stable line of change between spot rates and forward exchange rates.
Currency markets are incredibly volatile, and there is not a great deal that a government can do to change this short of taking direct control of the currency, which comes with its own host of problems.
Without taking any measures to stabilize exchange rates or currency value or to limit exposure to the volatilities of these exchange rates, however, businesses face a great loss of valuation and governments runs the risk of racking up huge deficits (or, conversely, rather worthless trade surpluses).
Through management of foreign direct investment in the government and government investment in both domestic and foreign programs, forward exchange rates can be somewhat managed and risks mitigated.
Interest Rates
The manipulation of interest rates by treasury departments and central banks is a complex task, and one that has an effect on these entities even as they have a direct effect on the interest rates themselves. Interest rate risk exposure exists for governments as well as for businesses, especially private banking institutions, all of which have complex balance sheets with many long- and short-term assets and liabilities, the combination of which could prove hugely detrimental to the organization due to interest rate fluctuations.
If, for instance, an organizations liabilities carried a significantly higher average interest rate than their assets (and if the asset principals did not significantly outweigh the liability principals) that organization would end up losing significant amounts of capital to interest payments, with possibilities for reversing this trend dependent on interest rate changes.
The manipulation of interest rates, then, becomes an increasingly important aspect of government intervention in the money supply as a method for risk management. Private companies and institutions can also try to manage their risks through limiting their exposure to interest rate changes and capitalizing on positive changes when they occur, but treasury management allows for more direct influence. Such influence is not without its drawbacks, however, and though central banks have been very active of late in dropping interest rates to increase the flow of capital, the ease of borrowing has separate dangers.
The dangers of not affecting interest rates at all, however, and letting them instead regulate and manipulate capital availabilities, leaves the market much more at the mercy of the vagaries of human impulses and motives that essentially make up any economy -- especially one based on the principles of a free (er) market. Failing to limit the economy's exposure to market fluctuations in the interest rate can allow these rates to skyrocket, even -- and perhaps especially -- in times of economic fear and hesitancy, which would create far worse recessive tendencies in the economy. Managing the risks involved with interest rate volatility creates a more stable and more productive economy -- and a more profitable private enterprise, as the case may be -- and is seen as an entirely necessary and well-founded activity of almost all central banks and/or treasury departments.
Currency Swaps
One last method of managing risk exposure for both large governments and private companies is through the relatively straightforward activity of currency swaps, which has the potential for very complex effects....
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