Currency Risk Flashcards
Translation Risk
The risk that changes in the exchange rate over time will change the value of assets overseas (like an overseas loan or subsidiary) when converted back into the home currency.
Economic Risk
Arises due to long term movement in currencies (long term transaction risk). This affects all companies, regardless of whether they buy/sell abroad.
Transaction Risk
The risk that the exchange rate will change unfavourably over time, such that the transaction is entered in a different rate than it is finally settled at.
Spot Rate
The exchange rate on the day of the transaction
Bid offer spread
The difference between the amount the bank will buy and sell currency at (representing their profit)
Bid Price
The higher price that a buyer (i.e. the bank) is prepared to pay for a currency. Buy low
Ask Price
The price a seller (i.e the bank) states they will accept. Sell high
Balance of payments
The difference between a county’s overseas earnings and spending.
Surplus in balance of payments
Where a country earns more from overseas than it spends- implies it is doing well and the exchange rate will strengthen.
Deficit in the balance of payments
Where a country spends more than it earns overseas, implying poor performance and so exchange rates will weaken.
Ticks
Foreign currencies are always quoted to 4dp. The smallest movement is foreign exchange currency (0.0001) is referred to as a tick.
Matching
Matching receipts in one foreign currency to payments in the same currency, reducing the amount that needs to be converted back.
Lagging
Paying amounts due later to match them against future receipts in anticipation of favourable exchange rate movements.
Leading
Paying amounts due earlier using funds already received in the currency in anticipation of unfavourable exchange rate movements
Netting
Centralised treasury department offsets payments made between divisions or subsidiaries in different countries to keep amounts exchanged to a minimum.
