Foreign exchange risk


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  • Foreign exchange risk

    1. 1. Group - 4Foreign-Exchange RiskManagement of Exposure Risk FOREX-Management of exposure risks
    2. 2. Authors of Presentation Vipin Das Sreejith Saranya S R Renjil Mathew Rinto Mathew Likhitha Jishnu Lijo Stalin FOREX Risk Management Manu C Pillali FOREX-Management of exposure risks
    3. 3. Foreign-Exchange Risk• The risk of an investments value changing due to changes in currency exchange rates.• The risk that an investor will have to close out a long or short position in a foreign currency at a loss due to an adverse movement in exchange rates. Also known as "currency risk" or "exchange-rate risk". FOREX-Management of exposure risks
    4. 4. • This risk usually affects businesses that export and/or import• But also affect investors making international investments• Financial risk management is the practice of creating economic value in a firm by using financial instruments to manage exposure to risk FOREX-Management of exposure risks
    5. 5. Foreign Exchange Exposure• Foreign Exchange Exposure is a measure of the potential change in a firms profitability,• net cash flow and /or market value of net assets due to a change in exchange rates. “When a US company sells to a foreign buyer and accepts thebuyers currency for payment, the US company bears the risk that the foreign currency depreciates and that it will receive fewer dollars once the foreign currency is converted back into the dollar.” FOREX-Management of exposure risks
    6. 6. TYPES OF RISK FROM FOREIGNEXCHANGE EXPOSURE • Transaction Risk • Translation Risk • Economic Risk FOREX-Management of exposure risks
    7. 7. Transaction RiskWhen a firm or individual has a receivable or apayable in a foreign currency the foreignexchange rate may change, causing an increasein the liability of the home countrys currency ora decrease in receipts in the home countryscurrency. FOREX-Management of exposure risks
    8. 8. Transaction Risk• The risk of changes in the expected value of a contract between its signing and its execution as a result of unexpected changes in foreign exchange rates.• Whoever makes a contract denominated in a foreign currency bears transaction risk.“Ocean Drilling has transaction risk if it borrows money in French francs or Japanese yen, and Hintz-Kessels- Kohl has transaction risk if it agrees to accept future payments for its vehicles in U.S. dollars.” FOREX-Management of exposure risks
    9. 9. Passive Transaction Risk Management• Denominate all contracts in domestic currency. This is a possible strategy for companies with market power.• Do nothing about transaction risk. This is a possible strategy for companies with a large number of small contracts in a large number of currencies FOREX-Management of exposure risks
    10. 10. Hedging• Insuring against transaction risk to reduce or eliminate the effects of unexpected changes in exchange rates.• You can hedge only at market rates. The effects of expected changes in exchange rates are incorporated in these market rates. Hedging is insurance. The purpose of hedging is to reduce or eliminate risks, not to make profits. FOREX-Management of exposure risks
    11. 11. HedgingThe purpose of hedging is to manage a firmsforeign exchange exposure by minimizing homecurrency outflows (payables/liabilities) andmaximizing home currency inflows(receivables/assets). FOREX-Management of exposure risks
    12. 12. Natural Transaction Risk Hedging• Centralize cash management to net all offsetting transactions, transactions which are long and short the same currency.• Time, lead and lag, offsetting business transactions in the same currency.• Create offsetting business transactions in the same currency. FOREX-Management of exposure risks
    13. 13. Translation RiskWhen a home country entity is required toconsolidate its foreign subsidiaries incomestatements and balance sheets into the homecurrency. Exchange rates may change, causingan increase in liabilities or a decrease in assetsas measured in home country currency terms. FOREX-Management of exposure risks
    14. 14. Translation Risk• Gains or losses from exchange rate changes that occur as a result of converting financial statements from one currency to another in order to consolidate them.• Every company having at least one subsidiary using a different functional currency bears translation risk. “MSDI has translation risk from having a subsidiary, MSDI Alcala de Henares, whose financial statements are kept in Spanish pesetas and not in U.S. dollars.” FOREX-Management of exposure risks
    15. 15. Hedging Translation Risk• Translation risk is hedged in the same ways as transaction risk.• It appears as if investors are indifferent to foreign currency translation gains and losses. FOREX-Management of exposure risks
    16. 16. Market Translation Risk Hedging• Forward Markets• Futures Markets• Money Markets FOREX-Management of exposure risks
    17. 17. Forward and Futures Markets1. Any currency, any amount, 1. Selected currencies, standard any maturity contracts, standard maturities2. Illiquid 2. Liquid3. Self-regulated OTC market 3. Government-regulated4. Contract with dealer exchange-based market5. Requires credit-worthiness 4. Contract with exchange6. Cash flow only at maturity 5. Requires margin account7. Settled by executing 6. Marked to market daily contract 7. Settled by offsetting trade8. Hedge by buying forward 8. Hedge by making a the short currency or selling forward the long transaction whose gains or currency losses offset those of the underlying position FOREX-Management of exposure risks
    18. 18. Forward and Money Markets• Money markets can always be used to synthesize forward markets.• Money market rates are used to set forward market rates.• Money market transactions are likely to be more costly than forward market transactions, since three transactions having their own bid-ask spreads are required to duplicate one forward market transaction with one bid-ask spread.• Money market transactions appear on the balance sheet; forward market transactions do not. FOREX-Management of exposure risks
    19. 19. Economic RiskThe effect of exchange rate changes on the longterm expected income streams, i.e., expectednet wealth of home country stockholders. Thisrisk is usually managed with physical location ofassets and liabilities. FOREX-Management of exposure risks
    20. 20. Economic Risk• Changes in competitive position as a result of permanent changes in exchange rates.• Every company buying or selling abroad or even just competing with foreign companies has economic risk. “Maybach has economic risk from manufacturing its automobiles in Germany for export to the United States, where it competes with Rolls Royces manufactured in England.” FOREX-Management of exposure risks
    21. 21. CONCLUSIONBy incorporating foreign exchange risk solutionsinto broader business strategy, we can helpprotect your profitability by managing yourexposure to exchange rates – whatever your riskappetite maybe. FOREX-Management of exposure risks
    22. 22. THANK YOUFOREX-Management of exposure risks