CURRENCY RISK IN INT’L TRADE

* Exchange rate exposure is also known as Translation

exposure/ Real operating exposure / Transaction exposure.

* Translation exposure also known as accounting exposure does

not involve cash flow.

* It provides insight to comparative performance of different

subsidiaries of MNCs operating in different currencies.

* When value of currency of any host country changes, its

translated value in the domestic currency of parent country
also changes. The extent of change represents the magnitude of
translation exposure.
contd……
* If country maintains account in reporting currency (domestic
currency of parent company), then translation exposure do not
emerge.

•But as per prevalent practice maintain account in functional

currency (host country currency), translation exposure emerges
due to exchange rate fluctuations.

•Transaction exposure refers to change in exchange rate, on

account of the following factors:
•a) Export & Import of commodities
•b) Borrowing & lending in foreign currency
•C) Intra-firm flows
 HEDGING EXCHANGE RATE EXPOSURE
Two types of hedging:
1) Contractual hedge
2) Natural hedge

Contractual hedge includes:

• Forward market hedge
• Futures market hedge
• Options market hedge
• Money market hedge
In forward market hedge, the exporter sells ‘forward’ and
importer buys ‘ forward’.

Ex: Indian handicraft seller executes contract for $1000/- and is

expected to receive the sum after three months, but he fears
drop/ depreciation in the value of dollar. The spot as well as
forward rate is Rs 50/US$. If dollar depreciates to Rs 49 after
three months, the export earnings will be Rs 49000, but since
exporter has sold forward a similar amt. of dollar at 50 thus he
does not lose on the transaction.
Similarly if importer fears appreciation in the value of dollar, he
will buy the same amt. of dollars forward. If dollar appreciates
to Rs. 51 he will have to pay Rs 1000 more, thus he purchases US
$1000 with Rs 5oooo and saves lost of Rs 1000.
 Money market hedge
Under this system, depending on the receivables/payables the
exporter/importer takes money in money market. The system
works as under:

For importer, who has to make payment – first borrows local

currency, converts local currency into foreign currency and
finally invests the converted currency matching the tenure of
the payment.

For exporter, who has to receive payment, borrows the currency

of receivables, converts borrowed currency into local currency
and invests the amount coinciding with the receipt of export
proceeds.
 NATURAL HEDGING
Firms go for natural hedges, because contractual hedge
provides temporary protection. Different forms of NH are:-
1) Leads & Lags(accelerating / decelerating payments)
2) Cross hedging ( hedging ith other currency than the desired
currency)
3) Currency diversification ( transaction diversified over a
number of currencies)
4) Risk sharing( both buyer & seller share exposure risk)
5) Pricing of transactions (marking up/down of sale price)
6) Parallel loans (simultaneous borrowing & lending involving
four parties in two countries)