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Exchange Risk Management - G9

This document discusses international trade finance and exchange risk management. It defines foreign exchange as the conversion of one currency to another at a specific exchange rate. It also defines the different types of exchange risk businesses face when operating internationally, including transaction risk, economic risk, and translation risk. Finally, it outlines various internal and external techniques that companies can use to manage foreign exchange risk, such as forward contracts, currency futures, and invoicing in the domestic currency.

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Parvesh Aghi
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98 views14 pages

Exchange Risk Management - G9

This document discusses international trade finance and exchange risk management. It defines foreign exchange as the conversion of one currency to another at a specific exchange rate. It also defines the different types of exchange risk businesses face when operating internationally, including transaction risk, economic risk, and translation risk. Finally, it outlines various internal and external techniques that companies can use to manage foreign exchange risk, such as forward contracts, currency futures, and invoicing in the domestic currency.

Uploaded by

Parvesh Aghi
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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International Trade Finance

Exchange Risk Management

CPEIM, Group-9, Batch 19


Exchange Risk Management

 What is Foreign Exchange ?

 Foreign exchange (Forex or FX) is the conversion of one currency into another at a
specific rate known as the foreign exchange rate. 
 Major 4 Currencies used for Trading are
1. USD
2. EURO
3. GBP
4. Japanese Yen
Exchange Risk Management

 What is Foreign Exchange market ?

 The foreign exchange market is an over-the-counter (OTC) marketplace that


determines the exchange rate for global currencies.
 It is, by far, the largest financial market in the world and is comprised of a global
network of financial centres that transact 24 hours a day, closing only on the
weekends.
 Currencies are always traded in pairs, so the "value" of one of the currencies in that
pair is relative to the value of the other.
Exchange Risk Management

 What is Foreign Exchange Risk?

 Foreign exchange risk, also known as exchange rate risk, is the risk of financial impact due to
exchange rate fluctuations.
 In simpler terms, foreign exchange risk is the risk that a business’ financial performance or
financial position will be impacted by changes in the exchange rates between currencies
What are the types of Foreign Exchange Risk?

TRANSACTION ECONOMIC RISK TRANSLATION


RISK RISK
Transaction Risk

 Transaction risk to the adverse effect that foreign exchange rate fluctuations can have on a completed transaction prior to settlement.
 It is the exchange rate, or currency risk associated specifically with the time delay between entering a trade or contract and then
settling it.

 Example
 Company A, based in Canada, recently entered into an agreement to purchase 10 advanced pieces of machinery from Company B,
which is based in Europe. The price per machinery is €10,000, and the exchange rate between the euro (€) and the Canadian dollar ($)
is 1:1. A week later, when Company A commits to purchasing the 10 pieces of machinery, the exchange rate between the euro and
Canadian dollar changes to 1:1.2

 The above is an example of Transaction Risk, as the time delay between transaction and settlement caused Company A to pay more,
in Canadian dollars.
Economic Risk

 Economic risk also known as forecast risk that a firm’s market value is influenced by unexpected
exchange-rate fluctuations.
 Economic risk can affect the present value of future cash flows. This type of exposure are due to
Government policy and can be a long-term risk for the firms.

 Example
 A Canadian furniture company that sells locally will face Economic Risk from furniture importers, especially if the
Canadian currency unexpectedly strengthens.
Translation Risk

 Translation risk is the exchange rate risk associated with companies that deal in foreign currencies and list foreign assets
on their balance sheets.
 Companies that own assets in foreign countries, such as plant and equipment, must convert the value of those assets from
the foreign currency to the home country's currency for accounting purposes.

 Example
 Company A, based in Canada, reports its financial statements in Canadian dollars but conducts business in U.S.
dollars. In other words, the company makes financial transactions in United States dollars but reports in Canadian
dollars. The exchange rate between the Canadian dollar and the US Dollar was 1:1 when the company reported its Q1
financial results. However, it is now 1:1.2 when the company reported its Q2 financial results.
 The above is an example of translation risk. The company’s financial performance from Q1 to Q2 is negatively
impacted due to the translation from the U.S. dollar to the Canadian dollar.
To correct the balance of payments
equilibrium. …
Protect the value of the national currency. …

Prevent capital flight. …


Objective of
Foreign
Exchange Risk Protect local industry. …
Management

Build foreign exchange reserves…


Foreign Exchange risk Management Techniques

 Internal Techniques - within the business itself


 Leading and Lagging : Leading means advancing a payment i. e. making a payment before it is due.
Lagging involves postponing a payment i. e. delaying payment beyond its due date.
 Invoicing in Domestic Currency :  Invoicing in domestic currency, an exporter can shift transaction
risk to his customer abroad.
 Netting : Exposure netting is a method of hedging currency risk by offsetting exposure in one currency
with exposure in the same or another currency.
Foreign Exchange risk Management Techniques

 External Techniques - involve dealing with a third party


 Forward contract : A forward contract is a foreign exchange agreement where you lock in the exchange rate
of a future foreign currency payment today. It allows entities to protect themselves from exchange rate
movements by entering into a contract with a third party.
 Future Contract : Futures contracts are standard legal agreements between two parties agreeing to buy or sell
a given amount of currency at a later date, at a specific fixed price. You can use futures to lock in favourable
prices for a transaction you need to make in the future.
 Option Contracts : Options give companies the right, but not the obligation, to buy or sell the currency at a
specific exchange rate, called the strike price, on or before a specific date when the option expires.
 Swap Contracts :Swaps are contracts that involve an agreement between two parties to exchange cash flows
in one currency for a series of cash flows in another currency. This exchange occurs at agreed intervals over a
set period.
Foreign Exchange risk Management Techniques for
MSME`s

 Hedging strategies can protect a foreign investment from currency risk for when the funds are converted
back into the investor's home currency.
 Currency ETFs can be used to mitigate a portfolio's exposure to the performance of a currency exchange
rate.
 Forward contracts provide a rate lock so that the international funds can be converted back into the home
currency at a later date.
 Options contracts offer more flexibility than forwards but come with an upfront fee or a premium.
In a nutshell

 Foreign exchange risk is part and parcel of doing international business or investing in other
countries.
 Currency fluctuation may adversely impact your operations and investments, leading to income
uncertainty and losses.
 Types of foreign exchange risks include economic, transactional, and translation.
 External foreign exchange risk mitigation strategies for hedging against transactional risks include
forward contracts, currency futures, currency options, and currency swaps.
 Internal foreign exchange risk mitigation strategies that you can implement include invoicing in local
currency, netting, matching, and leading and lagging.
Thank You

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