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
Risk management - Kevin

11/21/09

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
Risk management - Kevin

11/21/09

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
Risk management - Kevin

11/21/09

Foreign exchange risk: techniques of management

Transaction risk (short term):

Hedging using currency forwards or futures Adaptation in production and marketing strategy (plant location, input mixing, input sourcing, market selection, product planning, pricing, etc )

Real operating risk (long term):

Translation risk: accounting risk

11/21/09

Risk management - Kevin