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
