10 - Managing Overseas Risk

Question 1

Types of overseas risk

Answer 1

Transaction risk - changes in e/r will affect values of transactions

Economic risk - long run impact of Transaction risk on value of business

Translation risk - reported performance is affected by e/r movements (accounting problem)

Question 2

Practical methods to manage transaction risk

Answer 2

• Invoice in Sterling
• Leading and lagging (expedite/delay payment - speculation!)
• Asset-liability matching
• Foreign currency bank accounts

Question 3

How to reach Forward rate from spot rate

Answer 3

Add a discount - foreign currency will depreciate

Deduct a premium - foreign currency will appreciate

Question 4

Number of contracts - FX future/option

Answer 4

Transaction amount in £/Contract size in £

Converted to £ at current futures/strike price

Question 5

Calculate premium or gain/loss on FX Future/Option

Answer 5

Premium/gain/loss x contract size x # contracts

Then convert back to £! (Future rate for gain/loss, spot rate for premium)

Question 6

Interest rate parity

Answer 6

Forward rate = Spot rate x 1+OS interest rate/1+UK interest rate

Question 7

Purchasing power parity

Answer 7

Expected future rate = Spot rate x 1+OS inflation rate/1+UK inflation rate

Question 8

Other risks that increase when trading overseas

Answer 8

Physical risk (lost in transit)
Trade risk (order cancelled)
Liquidity risk
Credit risk