Exchange Rate Risk

A common definition of exchange rate risk involves the impact of unexpected exchange rate
changes on company value. In particular, it is defined as a possible direct loss (due to unhedged risk) or
indirect loss of company cash flow, assets and liabilities, net profit, and stock market value of exchange
rate changes. Exchange Rate risk also known as FX risk, currency Risk and Foreign Exchange risk.
Exchange Rate risk is sometimes also referred to as the risk that investors face when they need to settle
long or short positions in foreign currencies, and losses due to exchange rate fluctuations.

Types of Exchange Rate Risk

 Transaction Risk
 Economic Risk
 Translation Risk

Transaction Risk
If the company has contractual cash flows (accounts receivables and accounts payable) whose
value is affected by unexpected changes in the foreign exchange rate denominated in the contract, the
company has Transaction risk. In order to understand the domestic value of its foreign currency value
cash flow, the company must replace foreign money for the currency. As the company faces the volatile
foreign exchange market, the company faces the risk of changes in foreign exchange and local currency
exchange rates when the exchange rate fluctuates and the contract is negotiated at a fixed price and
delivery date. It refers to the risks associated with changes in exchange rates between the transaction
and close the transaction initiated by the company.

Economic Risk
Economic risks basically reflect the risks that the company's future operating cash flow will
receive from exchange rate changes. In essence, the economic risks involved in influencing exchange
rate changes on revenue (domestic and export sales) and operating expenses (domestic and imported
input costs) of. Economic risks generally applicable to the parent company and the present value of
future cash flows of overseas subsidiaries business. Determine strategy is critical for the development of
various types of management of currency risk and currency risk indicators.

Translation Risk
The risk of Translation is basically the balance sheet exchange rate risk and the valuation of the
associated exchange rate transferred to the foreign subsidiary, which in turn merges the foreign
subsidiary to the parent company's balance sheet. The Translation risk of a foreign subsidiary is usually
measured by the risk of net assets (assets minus liabilities) and potential exchange rate changes. When
the financial statements are consolidated, they can be translated according to the exchange rate at the
end of the period or the average exchange rate of the period, depending on the accounting regulations
affecting the parent company. Therefore, although the income statement is usually converted at the
average exchange rate for the period, the balance sheet risk exposure of the overseas subsidiaries is
usually converted at the current exchange rate at the time of the merger.

Importance of Exchange Rate Risk Management

Managing currency risk exposure is an important function to reduce loopholes in the company's
major exchange rate movements. These vulnerabilities are mainly from companies participating in
international business and investment, and exchange rate changes may affect profit margins through
their impact on input sources, output and debt markets, and asset value. Increasingly, the company's
board of directors is cautious in managing currency risks, especially after the currency crisis of the past
decade, and the attendant international community's high attention to accounting and balance sheet
risk.
In an era of increasingly globalized and currency volatility, changes in exchange rates on the
company's operations and profitability had a significant impact. Exchange rate fluctuations affect not
only multinational corporations and large companies, but also affect the small and medium enterprises,
even those only in their business enterprises. Although the exchange rate risk understanding and
management of business owners is an obvious theme, but investors should be familiar with it, because it
could have a huge impact on their holdings.

Hedging Strategies
1. Transaction risks are often strategically hedge to keep cash flow and earnings, reliant on the
company's financial perspectives for the future direction of the relevant currency.
 Most companies use strategic hedging to hedge the trading currency risk associated with short-
term accounts receivable and accounts payable transactions, while strategic hedging is used for
longer-term trading.
 Some companies have decided to use passive hedging, which involves maintaining the same
hedging structure and execution during the periodic hedging, no matter how the money is
expected - that is, it does not require companies to adopt monetary point of view.
 To reduce the transaction risk with natural hedging is very helpful. The reason for excluding
foreign exchange risk is an effective form of hedging because it helps to reduce the profit that
banks take when they exchange money. Natural hedging is also a very simple understanding of
hedging.
2. Translation risk is rarely hedged in non-systematically way, frequently to avoid the effect of a
probably unexpected currency shock on net assets.
 The main risk to the long-term risks associated with foreign, such as the international
investment, evaluation of secondary companies and debt structure. However, long-term nature
of these projects as well as currency conversion affect the balance sheet rather than the income
statement of the company by the fact that the conversion risk of the hedge is no longer a
priority for management. For currency risk conversion of subsidiary value, the standard practice
is to hedge the net balance sheet risk exposure, that is, the net assets of the subsidiary (total
assets minus liabilities) that may be affected by adverse exchange rate changes.
 Companies can use an optimization model to design an optimal hedging strategy to manage
their currency risk. Hedging the remaining currency risk after optimizing debt composition is a
daunting task. In addition to optimization, companies can use tactical hedging to reduce residual
currency risk. In addition, if the exchange rate does not move as expected, the translation risk
hedging may result in fluctuations in cash flow or earnings. Therefore, hedging translation risk
usually involves careful weighing of hedging costs and non-hedging potential costs.
3. Economic risk is usually hedged for the remaining risks It is difficult to measure the economic risk
because it reflects the possible effect of exchange rate actions on the current value of cash flows for
future cash flows. It should measure the potential impact of the exchange rate variation in the rate
of interest rate used to assess the flow of income and expenses within a given period. In this
instance, the impact of each process can eliminate production taxes and markets, net economic risks
of companies investing in many foreign markets. In addition, if the exchange rate changes follow the
 inflation difference (through purchasing power parity), and the company's subsidiaries face cost
inflation higher than the general inflation rate, the company may find its competitiveness is
declining, and its original value is worsened due to exchange rate adjustment. PPP. In this case, the
company can best hedge its economic risk by creating payables (such as financing operations) in a
currency in which the company's subsidiaries experience higher cost inflation (the currency in which
the company's value is susceptible).
Hedging strategies create efficient boundaries as an integrated approach to dealing with
currency risk rather than buying sophisticated corporate treasuries, rather than buying a blank
vanilla hedge to cover some foreign exchange exposures. In practice, the hedge costs a hedge
against the size of the hedge size to an efficient range. Therefore, an efficient range determines the
most dangerous hedging strategy.

Operational and Financial Hedging

Financial Hedges is a company that deals with reducing the risk of specific properties.
Operational hedging is a company that uses its capabilities to reduce its output to a basic risk. Two
types of hedging can effectively reduce the company's risk.
There are a number of airports to manage the exposure of jet fuel costs. Air Lines prices are
used to reduce the fuel hedges, such as financial stocks and fuel pass-deals, to reduce fuel prices.
Furthermore, there is a choice to use the genuine options embedded in their operations to hedge
the aviation fuel price exposure. Some of the genuine options that can be used by airlines to trigger
their risks to fuel prices include: the diversity of their navy, the use of fuel-efficient fleets and the
lease of the aircraft's aircraft. The diversity of an aircraft navy and the use of a leased navy allow an
airline to adjust the functionality of its operational fleets. The overall exposure of a fuel-sized vessel
airbag reduces prices.
The proof of this analysis is clear: Firstly, the significant exposure to air fuel prices is shown;
Secondly, both the airline and operational financial managers are using their risks to fuel prices;
Third, airlines use to complete operational and financial hedges. The last and most surprising results
show that, financial hedges provide mixed results about the value of the firm's value, while the
operational value of the operational hedges' actually causing harm to its shareholders. It is
important to use performance or financial hedges.

Complements or Substitute
To check if the performance and financial hedges will be filled or replaced. The Model aircraft
refuses to use financial stocks against all three operational Risk management. More formal modeling
is defined:
Hedgei,t = α0 +βdiversity(Fleet Diversityi,t) + βage(Agei,t) + βlease(Leased Fleeti,t) + (3.17) +
βDhedge(OtherHedgeDummyi,t) + βcontrol (Control Variablesi,t) + εi,t,
Where:
Hedge is the percentage of fuel consumption next year for "i" in airline revenue
Period "t",
Fleet Diversity is the flight scatter code during "T"
The average Air Force Navy Average age logarithm,
 The lease-laden lease is the percentage of the aircraft navy,
Flight currency derivatives, if you use interest rate, the only thing for others
derivatives or a fuel pass-through contract, otherwise zero,
And ε is a fixed error period.
There is a positive relationship between the aviation firms' positive relationship between airline
companies and the use of financial stocks (βdiversity>0), if the airline finances the financial and
operational hedges. On the contrary, a negative relationship is the replacement of operational and
financial hedges (βdiversity <0). As for the diversity of the navy, a positive (negative) relation
between the fleet of aircraft fleets and the use of financial categories suggests that two types are
(substitutions). A positive coefficient for the fleet of an aircraft navy (βage> 0) suggests that
functional and financial hedges are substitutes.

Conclusion
Companies use stocks to hedge their exposure to various risks. Hedging exposure draws great in
administrative and financial resources. Therefore, it is important for shareholders to know that
derivative hedging companies can add value to companies. Managers should evaluate whether they
should participate in the corporate risk management program. However, the mixed result of the hedging
can bear a steady value, requires more research in this area before making a firm decision about the
results of impact on the company's value. Different Hedging Techniques use to reduce the risk of
company exchange rate.