Foreign exchange risk, also known as currency risk, refers to the financial risk posed by unexpected changes in exchange rates. It affects investors and businesses involved in international trade or foreign investments. There are three main types of foreign exchange exposure: transaction, economic, and translation. Transaction exposure involves existing foreign currency transactions, economic exposure impacts future cash flows and firm value, and translation exposure affects financial reporting due to exchange rate movements between periods. Companies can use hedging strategies like forward contracts, options, and money market operations to eliminate or reduce foreign exchange risk.

2. FOREIGN EXCHANGE RISK
 Also known as exchange rate risk or currency
risk.
 Financial risk posed by an exposure to
unanticipated changes in the exchange rate
between two currencies.
 Investors and multinational businesses exporting
or importing goods and services or making
foreign investments throughout the global
economy are faced with an exchange rate risk
which can have severe financial consequences if
not managed appropriately.

3. TYPES OF FOREIGN EXCHANGE
EXPOSURES
Foreign
exchang
e
exposure
s
Transactio
n Economic Translation
exposure exposure
exposure

4. TRANSACTION EXPOSURE
 Involves the possible exchange on loss or gain
on existing foreign currency-denominated
transactions.
 To realize the domestic value of its foreign-
denominated cash flows, the firm must
exchange foreign currency for domestic
currency.
 Exchange rates may move by up to 10% within
any single year, which can significantly affect
a firm's cash flows, meaning a 10% decline in
the value of a receivable or a 10% rise in the
value of a payable. Such outcomes could be
troublesome as export profits could be negated

5. ECONOMIC EXPOSURE
 Also known as operating exposure.
 The degree that the market value is influenced
by unexpected exchange rate fluctuations.
 Such exchange rate adjustments can severely
affect the firm's position with regards to its
competitors, the firm's future cash flows, and
ultimately the firm's value.
 A firm’s economic exposure depends on the
structures of the input and the output
markets.

6. TRANSLATION EXPOSURE
 A firm's translation exposure is the extent to
which its financial reporting is affected by
exchange rate movements.
 The exchange gain or loss occurring from the
difference in the exchange rates at the
beginning and the end of the accounting period.
 A firm is exposed to translation loss, if it uses
current exchange rate to translate its assets
and liabilities.

7. METHODS USED IN TRANSLATING ASSETS
AND LIABILITIES
Current Monetary or Temporal Current rate
or non- non-
method method
current monetary

8. HEDGING FOREIGN EXCHANGE RISK
 A foreign exchange hedge (FOREX hedge) is
a method used by companies to eliminate or
hedge foreign exchange risk resulting from
transactions in foreign currencies .
 This is done using either the cash flow or
the fair value method.

9. ALTERNATIVES
 Three alternatives available to companies to
hedge against the foreign exchange exposure:
 Forward contract
 Foreign currency option
 Money market operations