Foreign Exchange Risk

By: DEEPAK DUTT PANDEY 032

Foreign Exchange Risk

Foreign exchange risk is the risk that the value of an asset or liability will change because of a change in exchange rates. Because these international obligations span time, foreign exchange risk can arise.

Types of Risk
Financial Risk Political Risk Country Risk

Financial Risk
Refers more generally to unexpected events in acountrys financial, economic, or business life Examples of financial risks currency risk
interest rate risk Inflation risk unexpected changes in the current account balance unexpected changes in the balance of trade

Political Risk
The risk that a sovereign host government will unexpectedly change the rules of the game under which businesses operate Examples of political risks
Expropriation risk Disruptions in operations Protectionism Blocked funds Loss of intellectual property rights

Country Risk
Macro risks - affect all firms in a host country Micro risks - specific to an industry, firm or project in a country Whether a particular country risk is macro or micro affects the diversifiability of the risk

Sources of Risk
Transaction Exposure: The risk that the domestic cost or proceeds of a transaction may change. Translation Exposure: The risk that the translation of value of foreign-currency-denominated assets is affect by exchange rate changes. Economic Exposure: The risk that exchange rate changes may affect the present value of future income streams.

Hedging and Speculating

Hedging is the act of offsetting an exposure to risk. Speculation generates and exposure to risk.

Long and Short Positions

People are long in a foreign currency if the value of their foreign-currency-denominated assets exceeds the value of their foreigncurrency-denominated liabilities. People are short in a foreign currency if the value of their foreign-currency-denominated assets is less than the value of their foreigncurrency-denominated liabilities.