Completion of this chapter will enable you to:

 Explain what is meant by financial risk and consider its implications.

 Describe the various types of financial risk.
 Explain the use of the exchange rate equivalency model in the context of alternative
financial strategies.
 Analyse the issues relating to interest rate risk.
 Analyse the issues relating to foreign currency exchange rate risk.
 Appreciate the importance of financial risk management.
 Consider the various methods used for the hedging of financial risks.
 Explain the use of some of the wide range of derivatives available for companies to hedge
foreign currency exchange rate and interest rate risk.
 Evaluate the alternative financial risk management strategies.
 Describe how behavioural finance may explain irrational behaviour of investors.

1. Why is financial risk particularly important to international companies?

2. What is interest rate risk?
3. What is meant by describing a forward exchange rate as being at a premium or at a
discount to the spot rate?
4. What is hedging?
5. What is a derivative?
6. What are the differences between currency futures and foreign exchange forward
contracts?
7. What is an interest rate swap agreement?
8. What are the risks associated with hedging foreign currency risk and interest rate risk?

 Identify the sources of financial risk faced by companies and outline the reasons why
such exposure to risk has increased so much in recent years and continues to increase.
 What has been the impact of the 1973 oil crisis with regard to the world currency
markets and foreign currency exchange rates.
 What are the financial risks related to the level of a company’s gearing?
 Explain the implications of the financial risk faced by companies having fixed interes
loans compared with those having floating interest rate loans.
 Outline what is meant by the ‘spread’ of foreign currency exchange spot rates.
 Describe the relationship between foreign currency spot rates and future rate (one
month, three months, six months, etc.) premiums and discounts.
 Explain, with regard to the foreign currency exchange rate risks faced by companies,
what is meant by economic exposure; transaction exposure; translation exposure.
 What are the main types of hedging techniques available to companies in their
management of foreign exchange and interest rate risk exposures.
 Briefly describe how the use of derivatives: options; futures; swaps; and swaptions,
may be used to hedge both foreign exchange and interest rate risk.