CIMA BA1 Syllabus D. The Financial Context Of Business - Types of foreign currency risk - Notes ^{1 / 8}

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

Liquidity risk

is the risk that an asset or investment cannot be sold quickly enough to avoid a loss or secure the desired return.

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!