Foreign Currency Exposure And Risk


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Risk and exposure out of international trade and business due to change in foreign currency rate

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Foreign Currency Exposure And Risk

  1. 1. Foreign Exchange Exposure and Risk. World is changing faster than human Endeavor
  2. 2. Currency Exposure <ul><li>Short Term </li></ul><ul><ul><li>Accounting ( Translation) </li></ul></ul><ul><ul><li>Cash Flow </li></ul></ul><ul><ul><ul><li>Contractual( Transactions) </li></ul></ul></ul><ul><ul><ul><li>Anticipated </li></ul></ul></ul><ul><li>Long Term </li></ul><ul><ul><li>a. Operating </li></ul></ul><ul><ul><li>b. Strategic </li></ul></ul>
  3. 3. Exposure and Risk <ul><li>Though exposure and risk are used interchangeably </li></ul><ul><li>But Exposure is the measure of the sensitivity of the value of the financial item( asset liabilities or cash flow) to change in relevant risk factor </li></ul><ul><li>while Risk is a measure of variability of the value of the item attributable to the risk factor. </li></ul><ul><li>Example: Firm export import having significant exposure to Foreign exchange rate. But may not perceive significant risk as the dollar –rupee exchange rate is stable for last so many months </li></ul>
  4. 4. ( Accounting) Translation Exposure <ul><li>Translation Exposure is also known as the Accounting Exposure </li></ul><ul><li>A firm may have assets and liabilities denominated in foreign currency. </li></ul><ul><li>Accounting standard which governs the reporting and disclosure practices, the firm must translate the values of these currency –denominated items into home currency and report these in the balance sheet. </li></ul>
  5. 5. Translation Exposure <ul><li>Translation exposure typically arise when a parent multinational company required to consolidate a foreign subsidiary's financial statement </li></ul><ul><li>Example At the beginning of the financial year the subsidiary has real estate, inventories and cash valued at $100000, $200000, and $150000 respectively the spot rate is 1$= 46 Rs, by the close of financial year the values are changed as dollar depreciated to Rs at 1$ = 42Rs here the Indian concern with USA subsidiaries will make huge loss of $450000*(Rs 46 – Rs 42). </li></ul>
  6. 6. Translation Loss or gain <ul><li>The loss suffered by converting the assets and liabilities from foreign currency to domestic currency is known as transaction loss. </li></ul><ul><li>Similarly for the gain. </li></ul>
  7. 7. ( Contractual) Transactions Exposures <ul><li>It measures the sensitivity arises when the assets or liabilities are liquidated due to change in the exchange rate. </li></ul><ul><li>Examples: A currency has to be converted in order to make or receive payment for goods and services- import payable or export receivables denominated in a foreign currency </li></ul><ul><li>A currency has to be converted to make a dividend payment, royalty, payment and receivable to repay foreign loan and interest. </li></ul>
  8. 8. Transaction Risk <ul><li>An unanticipated change in the exchange rate has an impact favorable or adverse on its cash flows. </li></ul><ul><li>Transaction risk can be defined as a measure of variability of assets and liabilities when they are liquidated. May lead to exchange gain or loss. </li></ul><ul><li>The key difference between transaction exposure and translation is that former has impact on cash flows while latter has no direct effect on cash flows. ( This is true if there is no tax effects arising out of translational gains or loss. ) </li></ul>
  9. 9. Anticipated <ul><li>Sometimes transaction is being negotiated, all terms more and less finalized but a contractual agreement yet to be entered into. </li></ul>
  10. 10. Strategic exposure <ul><li>The focus impact of cash flows of firm in years to come </li></ul><ul><li>Horizon are long nothing is contractually fixed and the impact of exchange rate fluctuations can have substantial, sustained implication </li></ul><ul><li>In long run exchange rate effect can undermine a firm's competitive advantage by raising by raising it’s cost above the competitors cost. </li></ul>
  11. 11. <ul><li>Unanticipated exchange rate change on firm’s revenue, operating cost and operating net cash flow over a medium term horizon </li></ul><ul><li>Change in exchange rate can affect on sales volume, input cost of imported materials, labour costs, interest costs, inflation, income distribution </li></ul>
  12. 12. Operating Exchange Exposure <ul><li>Of two kind of long term exposure operating and strategic . </li></ul><ul><li>Operating exposures capture the impact of unanticipated exchange rate changes on the firm’s revenue, operating costs and operating net cash flows over a medium term say up to three years. </li></ul>
  13. 13. Thank You <ul><li>Exposure can be Covered , Risk can be Neutralized completely it needs self confidence, patience and courage to be Creative . Not stress , tension and frustration to feel desperate.. </li></ul>