Foreign Exchange Risk- Ahmad Al Marri

Foreign exchange risk (also known as exchange rate risk or currency risk) is a financial risk stood by an exposure of unexpected changes of exchange rates between two different currencies. Investors and many international businesses exporting and importing goods and services or making overseas investments throughout the global economy are faced with an exchange rate risk which can have severe financial consequences if it not managed properly.

Types of exposure:

Foreign currency exposures are generally categorized into three different types: transaction exposure, economic exposure, and translation exposure. These exposure types can position the risks to firm’s cash flows, competitiveness, market value, and financial reporting.

Transaction Exposure:

A company has transaction exposure when it has contractual cash flows from receivables and payables whose values are in subject to surprising changes in exchange rates due to a contract being denominated on a foreign currency. To understand the domestic value of its foreign denominated cash flows, the foreign exchange the foreign currency for domestic one. As the businesses negotiate their contracts with the set prices and delivery dates in the face of a very volatile foreign exchange market with the exchange rates are continually fluctuated, as businesses can face a risk changes in in the exchange rates between foreign and domestic currencies.

Economic Exposure:

A firm has economic exposure to the amount of that its market value is influenced by unexpected exchange rates fluctuations. Such exchange rates adjustments can rigorously affect the firm’s position with regard to its competitors. The firm’s future cash flows. And ultimately firm value.

Translation Exposure:

A business translation is the extent to which its financial reporting is affected with the movement of exchange rates. As all businesses prepare consolidated financial statements for purpose of reporting. The consolidation process for multinational organizations involves in translating foreign assets and liabilities or the financial statements of foreign subsidiaries from foreign to domestic currency.