INTERNATIONAL TRADE;

CURRENCY RISK, TRANSACTION

RISK AND ECONOMIC RISK, THE
HEDGING OF RISKS

Presented

by

Wesley CHIPOFYA
 INTERNATIONAL TRADE
AND
RISKS
International trade is the exchange of capital,
goods and services across international borders or
territories, which could involve the activities of the
government and individual.

This type of trade rise to a world economy, in which

prices, or supply and demand, affect and are affected
by global events.
 INTERNATIONAL TRADE
AND
RISKS

International trade involves the

following risk;
currency risk,
transaction risk
economic risk.
 INTERNATIONAL TRADE
AND
RISKS
Currency risk
Is the potential risk of loss from fluctuating
foreign exchange rate when an investor has
exposure to foreign currency of in foreign
currency traded investment. Foreign risk is
sometimes referred to as exchange rate risk, it is
important to understand because foreign
currency exchange rate can drastically change an
investor’s total return on a foreign investment,
despite how well the investment performed.
 INTERNATIONAL TRADE
AND
RISKS
Currency risk

Currency risk can also create an opportunity

for investors when the interest rates between
two countries reflect the expected changes in
their exchange rates.
 INTERNATIONAL TRADE
AND
RISKS
For example, if interest rate are higher
in Britain the U.S dollar will probably
drop in value relative to the British
Pound, this is because when interest
rates increase in a particular county
international currencies flow into that
country to take advantage of the higher
yields and this pushes the value of that
country’s currency higher.
 INTERNATIONAL TRADE
AND
RISKS

Currency risk also means that foreign

bond investors can increase their
exposure to foreign exchange markets.
Another example of currency risk is
when the company´s product is sold to
customers overseas who pay in their
local currencies.
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AND
RISKS

The currency risks can be divided into three

different categories: transaction risk,
translation risk and economic risk.
 INTERNATIONAL TRADE
AND
RISKS
Transaction risks:
Occurs when the company has monetary
assets and liabilities denominated in a
foreign currency at a given time on the
balance sheet, and that in the future you
have expected commercial and financial
flows of a foreign currency.
 INTERNATIONAL TRADE
AND
RISKS

A transaction risk can be expressed as of

either a short-term claim/debt or long-term
claim/debt. A transaction risk is both realized
and unrealized income/loss, which is
reported as either operating income,
expenses or as financial income/expenses.
 INTERNATIONAL TRADE
AND
RISKS

Translation risks arises when the

company has foreign subsidiaries or
other real assets (ex. houses, forest or
land) that needs to be translated form
these accounts to the parent company´s
home currency in times of Financial
Statements.
 INTERNATIONAL TRADE
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RISKS

The structure of a translation risk is

directly related to the accounting
principle of the parent company. Foreign
exchanges gains/losses are not included
in cash flow or have any tax related
impact but remain unrealized until the
subsidiary or the assets are sold.
 INTERNATIONAL TRADE
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RISKS
.
Economic risk:
Occurs in firms that has activities with an
international focus. Economic risk is used to
describe the economic value of the parent
company´s home currency of a subsidiary´s
foreign future cash flow in its own foreign
currency.
 INTERNATIONAL TRADE
AND
RISKS

In order to measure the combined

financial exposure it is required to
consider all of the subsidiaries flows in
their own currency and foreign
currency and also to the parent
company´s own exposure.
 INTERNATIONAL TRADE
AND
RISKS
Transaction risk

Is a risk that accompany will incur

losses in a transaction comprising
multiple currencies due to exchange
rate movements.
 INTERNATIONAL TRADE
AND
RISKS

Companies often engage in transactions

involving more than one currency, in
executing these transactions companies
must repatriate on any foreign
currencies received as payment this
repatriation occurs at a market exchange
rate which is vulnerable to fluctuation.
 INTERNATIONAL TRADE
AND
RISKS
.
These transactions usually complies a lag between
execution and settlement, and this respect,
transaction risk is the risk that the relevant
exchange rate will unfavorably fluctuate during
this lag, resulting in potentially serious losses to
the company in question to illustrate suppose there
is a three day lag between a transaction’s execution
and settlement the company is receiving payment
in MWK which they must repatriate into USD.
 INTERNATIONAL TRADE
AND
RISKS
A transaction risk is the risk that the MWK
to USD exchange rate will decrease during
days lag. Transaction risk increases as time
lag widens between a transaction’s execution
and settlement. Just as a transaction risk
comprises the risk of loss, it also comprises
the possibility of gains should favorable
exchange rate movement occur.
 INTERNATIONAL TRADE
AND
RISKS
Economic risk
Is the chance that macroeconomics
conditions like exchange rates, government
regulation, or political stability will affect an
investment, usually one in a foreign country.
 INTERNATIONAL TRADE
AND
RISKS
Economic risk is one reason
international investing carries more risk
than domestic investing. Shareholders
and bondholders often bear economic
risk undertaken by international
companies. Investors who purchase and
sell foreign government bonds are also
exposed. Economic risk may also add
opportunity for investors.
 INTERNATIONAL TRADE
AND
RISKS
Foreign bonds, for example, allows investors
to participate indirectly in the foreign
exchange markets and the interest rate
environments of different countries. But the
foreign regulatory authorities may impose
different requirements on the types, sizes,
timing, credit quality, disclosures, and
underwriting of bonds issued in their
country.
 INTERNATIONAL TRADE
AND
RISKS

Economic risk can be mitigated by opting

for international mutual funds because they
provide instant diversification, often
investing in a variety of countries,
instruments, currencies, or international
industries.
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AND
RISKS
Types of economic risk
Main types of economic risk are as follows;
Risk of rising prices of raw materials and
energy- the increase in prices for material
resources increases the cost of manufactured
products. If a company operates in a
competitive market, and product prices cannot
be raised, rising of cost leads to a decrease in
profitability.
 INTERNATIONAL TRADE
AND
RISKS
Types of economic risk
Risk of minimum wages increasing- Labor
costs increasing also increases product cost.
The government may increase the
mandatory minimum workers’ wages, and
this can lead to an increase in the size of all
wages in the economy.
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AND
RISKS
Types of economic risk

Risk of production prices reduction a

decrease in market prices for the company
production also leads to a decrease in
profitability, even if the costs remain stable.
 INTERNATIONAL TRADE
AND
RISKS
Types of economic risk
Interest rate risk (credit risk)- If a
company uses credit resources to project, the
rising of interest rate on loans can a have a
significant negative impact on financial
performance.
 INTERNATIONAL TRADE
AND
RISKS
Types of economic risk

Risk of higher taxes and duties rates- This risk

can be called economic legal risk. The growth of
existing taxes rates or introducing of new taxes
leads to a decrease in profits. The risk of new duties
on imports and exports introducing can also be
attributed to this category of economic risks. New
export or import duties may even lead to the
companies which conduct export or import activity
termination.
 HEDGING
OF
RISKS
HEDGE
Hedge is an investment position intended to
offset potential losses or gains that may be
incurred by a companion investment. Its
effectiveness is the amount of changes in the
fair value or cash flows of a hedge item that
is offset by changes in the fair value or cash
flows of a hedging instrument.
 HEDGING
OF
RISKS
It is used to reduce any substantial losses or
gains suffered by an individual or an
organisation. A hedge can be constructed
from many types of financial instruments
including stocks, exchange, traded funds,
insurance, forward contracts, swaps, options,
many types of over the counter and derivate
products and future contracts.
 HEDGING
OF
RISKS
HEDGING
Hedging is also known as the matching
approach. This is a method which is used in
determining the finance mix of working
capital management.
 HEDGING
OF
RISKS
HEDGING
It is concerned with a business which can
adopt a financial plan which matches the
expected life of the sources of funds raised
to finance assets. Thus, long-term finance
shall be used to fixed assets and permanent
current assets and short term financing to
finance temporary or variable assets.
 HEDGING
OF
RISKS
HEDGING
Hedging involves the offsetting or protecting
against the risk of diverse price movements
while simultaneously preserving the possibility
of profiting from favourable price movements.
Hedging a risk is similar to purchasing
insurance, to which a firm pays a premium
which is the cost of option and in exchange it
receives a cash flow in the event that the firm is
hedging against, actually occurs.
 HEDGING
OF
RISKS
HEDGING
However, if the event does not occur, then the
option expires as worthless and the money
spent to acquire the option is lost.
In effect, hedging is a transfer of risks without
buying insurance policies. It employs various
techniques but basically involves taking equal
and opposite positions in two different markets
such as cash and future markets.
 HEDGING
OF
RISKS
FORMS OF HEDGES
There are two forms; Natural and Non –
symmetric hedge.

Hedge
This is a situation in which an aggregate risk
can be reduced by derivatives transactions
between two parties called counterparties.
 HEDGING
OF
RISKS
FORMS OF HEDGES
They exist for many commodities, foreign
currencies, interest rates on securities with
different maturities and even common stocks
where portfolio managers want to hedge their
bets. These occur for instance, when futures are
traded between importers and a foreign
manufacturer for currency exchange rate to
which hedging reduces aggregate risk and
benefits the country.
 HEDGING
OF
RISKS
FORMS OF HEDGES
Non – symmetric
This is when one party wants to reduce some
type of risk and another party agrees to sell a
contract that protects the first party from that
specific event or situation. For instance,
insurance skims where an insurance
company can reduce certain types of risks
through diversification.
 HEDGING
OF
RISKS
 TYPES OF HEDGES
There are three type; short, long and perfect.

Short – this is where a firm or an

individual sells futures contracts to
guard against price declines. Since the
rising of interest rates will lower, bond
prices, then it will result in the decrease
value of bond futures contracts.
 HEDGING
OF
RISKS
 TYPES OF HEDGES
There are three type; short, long and perfect.

Therefore, if a firm or an individual needs to

guard against an increase in interest rates, a
futures contract that makes money if rates
rise should be used. That means selling, or
going short, on a futures contract.
 HEDGING
OF
RISKS
 TYPES OF HEDGES
There are three type; short, long and perfect.
 
Long – in which futures contracts are brought in
anticipation of (or to guard against) price increases.
 
Perfect - occurs when the gain or loss on the hedge
transaction exactly offsets the loss or gain on the up
hedged position.
 HEDGING
OF
RISKS
TOOL FOR HEGDING
There are two tools for hedging risk and these are
internal and external;
Internal hedging techniques
It uses tools which are internal to the firm and they
include:
 Netting it is possible to net the payments and
receipts among associated companies by settlement
of the inter affiliate debts for the net amount owing.
 HEDGING
OF
RISKS
TOOL FOR HEGDING
Matching, this matches a companies foreign
currency inflows with its out flaws

Leading and lagging, leading means paying

an obligation in advance of the due date
while lagging means delaying payments to
take advantage of the expected rise or fall in
prices.
 HEDGING
OF
RISKS
TOOL FOR HEGDING

Price variation, this involves increasing

selling price to counter exchange rate
fluctuations
 HEDGING
OF
RISKS
External hedging techniques
These involve contractual relationships and
include;
Hedging through forward contracts
Forward contacts obligate one party to buy the
underlying at a fixed price at a certain time in the
future from a counterpart who is obliged to sell the
underlying at a fixed price.
 HEDGING
OF
RISKS
External hedging techniques
These involve contractual relationships and
includes
Hedging through futures
Future contract is an agreement to buy a standard
quantity of a specific financial instrument at a
future date and at a price agreed between the
parties through open out cry on the flow of an
organised financial future exchange.
 HEDGING
OF
RISKS
External hedging techniques
These involve contractual relationships outside and includes
Hedging through options
Options contract allows the buyer to participate in the good
side of the risk while insuring against the bad side of risk.
An option has a right but no obligation to perform.
Hedging through swaps-
swap is a contract exchange cash flows over the life of the
contract. Swaps could involve currency of interest rate.
 HEDGING
OF
RISKS
IMPORTANCE OF HEDGING

 Tax laws may benefit those who hedge risk. That is

earnings will be lower than earnings.

Hedging against catastrophic or extreme risk may reduce

the likelihood and the costs of distress, especially for
smaller businesses.
 HEDGING
OF
RISKS
IMPORTANCE OF HEDGING

Hedging against catastrophic or

extreme risk may reduce the
likelihood and the costs of distress,
especially for smaller businesses.
 HEDGING
OF
RISKS

IMPORTANCE OF HEDGING

Hedging against risks may reduce

the under investment problem
prevalent in many firms as a result
of risk averse managers and
restricted capital markets.
 HEDGING
OF
RISKS
REASONS WHY COMPANIES
MANAGE RISKS
 Hedging against foreign exchange
risk and interest rate risk.
In maximising the shareholders
wealth by making the right investment
financial and dividend decisions and
risk management.
 HEDGING
OF
RISKS

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