| Abstract: | The Department of Defense (DoD) incurs numerous costs denominated in foreign currencies in fulfilling U.S. alliance and security agreements overseas. Between fiscal years 1993 and 1997, the DoD expended over $10.4 billion in foreign currencies to operate and maintain its overseas facilities, and estimates for fiscal years 1998 and 1999 are $5.4 billion. In line with the government's general, risk-neutral approach to financial risk, the DoD makes no attempt to control its foreign exchange exposure against currency fluctuations. As such, there are inevitable differences in amounts budgeted to fund the DoD's overseas operations and amounts subsequently required to pay them. This paper examines the implications of DoD foreign exchange rate policy and applies an alternative approach to foreign exchange rate risk—one more in line with private-sector practices and overall efforts to reform government operations. The results indicate that forward contracts would inject greater certainty into the budgeting and administration of these programs and might release limited defense funds for use elsewhere. |
