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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

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>