Syllabus E. Treasury And Advanced Risk Management Techniques E2. The use of financial derivatives to hedge against forex risk

E1a/E2a/B5d. Types of foreign currency risk 1 / 13

Syllabus E1a/E2a/B5d)

E1a) Discuss the role of the treasury management function within:
iii) The management of risk exposure.

E2a) Assess the impact on an organisation to exposure in translation, transaction and economic risks and how these can be managed.

B5d) Assess the impact of a project upon an organisation’s exposure to translation, transaction and economic risk.[3

Types of foreign currency risk


  • Risk that there will be losses when a subsidiary is translated into the parent company currency when doing consolidated accounts


  • Risk of exchange rates moving against you when buying and selling on credit, between the transaction date and actual payment date


  • Long term cashflow risk caused by exchange rate movements. 

    For example a UK exporter will struggle if sterling appreciated against the euro. 

    It is like a long term transaction risk

Options to manage these risks

  1. Only deal in home currency ! (commercially acceptable?)

  2. Do nothing ! (Saves transaction costs but is risky)

  3. Leading - Receive early (offer discount) - expecting rate to depreciate

  4. Lagging - Pay later if currency is depreciating

  5. Matching - Use foreign currency bank account - so matching receipts with payments then risk is against the net balance

  6. Another way of managing the risk is using:

    Hedging, options, futures, swaps and forward rates - more of these later!