Foreign exchange risk management

1
Foreign exchange risk management
2
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

3
Types of risk/ exposure

• Accounting/ translation exposure financial
  statements
• Economic exposure cash flows
• Transaction exposure present cash flows
• Real operating exposure future cash flows

4
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

5
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

6
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

7
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