Task 9 Flashcards
What is Exposure?
The risk, faced by companies involved in international trade, that currency exchange rate will change after the companies have already entered into financial obligations. Such exposure to fluctuating exchange rates can lead to major losses for firms
What is Volatility?
Volatility represents the degree to which a variable changes over time
What are the three types of currency risks?
- Transaction risk
- Economic/structural risk
- Translation/accounting risk
What is the transaction risk?
The exchange rate risk associated with the time delay between entering into a contract and settling it. The greater the time differential between the entrance and settlement of the contract, the greater the transaction risk because there is more time for the two exchange rates to fluctuate.
What is Economic/structural risk?
Due to changes in rates, operating costs will rise and make a product uncompetitive in the world market thus eroding profitability. There’s little that can be done about economic risk; it’s simply a routine business risk that every enterprise must endure.
What is Translation/accounting risk?
The exchange rate risk associated with companies that deal in foreign currencies or list foreign assets on their balance sheets. The greater the proportion of asset, liability and equity classes denominated in a foreign currency, the greater the translation risk.
Which three different hedging alternatives are there?
o Uncovered
o Use forward contracts
o Currency option
What’s meant by the uncovered hedging alternative?
Undercovered is a company does nothing extraordinary activity to hedge its currency risk.
What’s meant by the forward contract hedging alternative?
A forward contract means a forward transaction contains a delivery date further into the future. (f.e. 180 days) Buyer and seller agree to buy and sell currencies for settlement and predetermined exchange rates.
What’s meant by the currency option hedging alternative?
Currency option is an option which gives the company the right, but not the obligation to buy a certain amount of currency at a specific exchange rate on or before a specified date. But unlike a forward contract, companies are not obliged to buy the currency at the end of the period. The agreed price at which the exchange of currency may occur is called the exercise or strike price the date on which the option expires is the expiry date.
