Foreign exchange risk

management

11/21/09 Risk management - Kevin

 Foreign exchange risk:
meaning
 Value of a currency changes
frequently
 Affects firms engaged in international
transactions
 Assets, liabilities and cash flows are
affected through changes in
exchange rates
 Possibility of unfavourable changes -
Risk
11/21/09 Risk management - Kevin
 Types of risk/ exposure
 Accounting/ translation exposure:
financial statements
 Economic exposure: cash flows
 Transaction exposure: present cash
flows
 Real operating exposure: future cash
flows

11/21/09 Risk management - Kevin

 Translation exposure
 Occurs on consolidation of financial
statements of different units of MNCs
 When the value of currency of a
subsidiary changes, its translated value
in the domestic currency of the parent
company changes
 This change represents translation
exposure
 It is only an accounting exposure

11/21/09 Risk management - Kevin

 Transaction exposure
 Impact of exchange rate fluctuations
on present cash flows
 From transactions already entered
into
 Export and imort
 Borrowing and lending in foreign currency
 Intra firm fund flow in an international
company

11/21/09 Risk management - Kevin

 Real operating exposure
 Changes in exchange rates alter
future operating revenues and cost
streams of a company
 Changes in future cash flows from
changes in exchange rates
- real operating
exposure

11/21/09 Risk management - Kevin

 Foreign exchange risk:
techniques of
management
 Transaction risk (short term):
 Hedging using currency forwards or futures
 Real operating risk (long term):
 Adaptation in production and marketing
strategy (plant location, input mixing, input
sourcing, market selection, product planning,
pricing, etc )
 Translation risk: accounting risk

11/21/09 Risk management - Kevin