Currency Risk Flashcards
Transaction Risk
occurs in the course of normal international trading transactions
Translation Risk
exchange losses from accounting results from foreign branches and subsidiaries
Economic Risk
effect of exchange rate movement on international competitiveness of a company
Methods to reduce transaction risk w/o using capital markets…
~ invoice in own currency
~ net off receipts and payments
~ paying early
~ delaying payment
Option forward exchange contracts
~ transaction cannot be avoided
~ have choice of date of contract
Forward Discount
add to spot rate
Forward Premium
subtract from spot rate
Interest rate parity theory
difference between the spot and forward rate can be predicted by the diff in interest rates betwn 2 countries
Interest rate parity formula
IR = interest rate
forward rate = spot rate x (1 + O/S IR)/(1 + domestic IR)
Purchasing power parity (PPP) theory
LT exchange rates betwn currencies will reflect relative purchasing power of each country
Purchasing power parity (PPP) formula
forward rate = spot rate x (1 + O/S inflation)/(1 + domestic inflation)
Currency future contracts: BUY
agree to receive the contract currency
CUrrency future contracts: SELL
agree to supply contract currency
Currency Futures: Advantages
~ ease to buy and sell contracts (highly liquid market)
~ regulated market (reduced counterparty risk)
Currency Futures: Disadvantages
~ cannot be tailored
~ limited no. of currencies
~ broker fees
