Risk Management (2) Flashcards
What is translation risk?
Where a company has foreign-denominated assets or liabilities or a foreign subsidiary or branches
If domestic currency has appreciated against the foreign currency?
A translation loss is likely to arise.
If the domestic currency has depreciated against the foreign currency?
A translation gain is likely to arise
What are forex gains/losses
A concept of financial accounting, not cash flows
If debt covenants use book values?
Foreign currency gains and losses may have real economic consequences if a debt covenant is breached
What is hedge against a change in shareholders’ equity?
The total value of foreign currency denominated assets should match that of foreign currency denominated liabilitie
What is done to hedge against a change in debt/equity ratio?
The ratio of foreign currency debt/equity should be the same as the domestic company
What is economic risk?
The risk that cash flows will be affected by long-term exchange rate movements.
Why is economic risk a significant issue
As the value of a company is the present value of its future cash flows
What does economic risk affect?
The international competitiveness of a company
What may domestic producers face?
Tougher competition from overseas competition if the domestic currency appreciates
Can economic risk affect a business which does not export or import?
Yes
What is a transaction risk?
The short-term version of economic risk
What is the cause of a transaction risk?
The exchange rate changes between the contracting date of a specific export/import and the related receipt/payment of foreign currency
Similarity between economic and transaction risk?
This affects cash flows and so affects the value of the company
How can transaction risk be effectively managed?
Using both internal and external hedging techniques
