Risk
management
FOREIGN EXCHANGE RISK Group 4
Introduction
Foreign exchange risk, also known as
exchange rate risk, is the risk of financial
impact due to exchange rate fluctuations.
Investors and businesses exporting or
importing goods and services, or making
foreign investments, have an exchange-
rate risk but can take steps to manage (i.e.
reduce) the risk.
History
Many businesses were unconcerned with, and did
not manage, foreign exchange risk under the
international Bretton Woods system.
The currency crises of the 1990s and early 2000s,
such as the Mexican peso crisis, Asian currency
crisis, 1998 Russian financial crisis, and the
Argentine peso crisis, led to substantial losses from
foreign exchange and led firms to pay closer
attention to their foreign exchange risk.
Understanding Foreign
Exchange Risk
The risk occurs when a company engages in financial
transactions or maintains financial statements in a
currency other than where it is headquartered.
Foreign exchange risk can be caused by
appreciation/depreciation of the base currency,
appreciation/depreciation of the foreign currency, or
a combination of the two.
Types of foreign
exchange risk
Economic risk
Contingent risk
Transaction risk
Translation risk
Techniques to Manage
Foreign Exchange Risk
1. Forward contracts
2. Future contracts
3. Options
4. Swap
Advantages of Foreign
Exchange Risks
Fluctuations
Availibility of numerous products
Hedging
Disadvantages of
Foreign Exchange Risks
Huge losses even if there is a small
movement in the rates where the open
position is huge.
Additional cost
Margin requirements
Complex process
Causes of Foreign
Exchange Risk
Macroeconomic factors such as
significant swings in exchange rates
Government policies
Sovereign risk
Collapse of a foreign government
Credit risk
Managing risk
Transaction hedging
Translation hedging
Strategies other than
financial hedging
Examples of Foreign
Exchange Risk
Company A, based in Canada, recently entered into an
agreement to purchase 10 advanced pieces of machinery
from Company B, which is based in Europe. The price per
machinery is €10,000, and the exchange rate between the
euro (€) and the Canadian dollar ($) is 1:1. A week later,
when Company A commits to purchasing the 10 pieces of
machinery, the exchange rate between the euro and
Canadian dollar changes to 1:1.2. Is it an example of
transaction risk, economic risk, or translation risk?
Conclusion
Foreign exchange risk poses a threat, and it
is important to hedge open exposures. But
at the same time, it is wise to keep updating
the global information and gain from the
volatility offered by the foreign exchange
market by holding the open positions within
the risk appetite
Thank You
Aisha Jain – 205
Siddhi Jain – 206
Lakshya Jain – 81
Mahek Hotwani – 69
Khush Girdhani – 56
