FMF9
Syllabus G. Risk Management G1. The nature and types of risk

Types of foreign currency risk 1 / 2

Types of foreign currency risk

Translation

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

Transaction

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

Economic

  • 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!