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Foreign-Exchange Risk The risk of an investments value changing due to changes in currency

exchange rates. The risk that an investor will have to close out a long or short position in aforeign currency at a loss due to an adverse movement in exchange rates. Also known as"currency risk" or "exchange-rate risk". FOREX-Management of exposure risks

This risk usually affects businesses that export and/or import But also affect investors makinginternational investments Financial risk management is the practice of creating economic valuein a firm by using financial instruments to manage exposure to risk FOREX-Management ofexposure risks

Foreign Exchange Exposure Foreign Exchange Exposure is a measure of the potential changein a firms profitability, net cash flow and /or market value of net assets due to a change inexchange rates. When a US company sells to a foreign buyer and accepts thebuyers currencyfor payment, the US company bears the risk that the foreign currency depreciates and that it willreceive fewer dollars once the foreign currency is converted back into the dollar. FOREX -Management of exposure risks

TYPES OF RISK FROM FOREIGNEXCHANGE EXPOSURE Transaction Risk TranslationRisk Economic Risk FOREX-Management of exposure risks

Transaction RiskWhen a firm or individual has a receivable or apayable in a foreign currency theforeignexchange rate may change, causing an increasein the liability of the home countryscurrency ora decrease in receipts in the home countryscurrency. FOREX-Management ofexposure risks

Transaction Risk The risk of changes in the expected value of a contract between its signingand its execution as a result of unexpected changes in foreign exchange rates. Whoever makesa contract denominated in a foreign currency bears transaction risk.Ocean Drilling hastransaction risk if it borrows money in French francs or Japanese yen, and Hintz-Kessels- Kohlhas transaction risk if it agrees to accept future payments for its vehicles in U.S. dollars.

FOREX-Management of exposure risks

Passive Transaction Risk Management Denominate all contracts in domestic currency. This isa possible strategy for companies with market power. Do nothing about transaction risk. This isa possible strategy for companies with a large number of small contracts in a large number ofcurrencies FOREX-Management of exposure risks

Hedging Insuring against transaction risk to reduce or eliminate the effects of unexpectedchanges in exchange rates. You can hedge only at market rates. The effects of expectedchanges in exchange rates are incorporated in these market rates. Hedging is insurance. Thepurpose of hedging is to reduce or eliminate risks, not to make profits. FOREX-Management ofexposure risks

HedgingThe purpose of hedging is to manage a firmsforeign exchange exposure by minimizinghomecurrency outflows (payables/liabilities) andmaximizing home currencyinflows(receivables/assets). FOREX-Management of exposure risks

Natural Transaction Risk Hedging Centralize cash management to net all offsetting transactions,transactions which are long and short the same currency. Time, lead and lag, offsettingbusiness transactions in the same currency. Create offsetting business transactions in the samecurrency. FOREX-Management of exposure risks

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Translation RiskWhen a home country entity is required toconsolidate its foreign subsidiaries

incomestatements and balance sheets into the homecurrency. Exchange rates may change,causingan increase in liabilities or a decrease in assetsas measured in home country currencyterms. FOREX-Management of exposure risks

Translation Risk Gains or losses from exchange rate changes that occur as a result ofconverting financial statements from one currency to another in order to consolidate them. Everycompany having at least one subsidiary using a different functional currency bears translationrisk. MSDI has translation risk from having a subsidiary, MSDI Alcala de Henares, whosefinancial statements are kept in Spanish pesetas and not in U.S. dollars. FOREX-Managementof exposure risks

Hedging Translation Risk Translation risk is hedged in the same ways as transaction risk. Itappears as if investors are indifferent to foreign currency translation gains and losses. FOREX-Management of exposure risks

Market Translation Risk Hedging Forward Markets Futures Markets Money Markets FOREX-Management of exposure risks

Economic RiskThe effect of exchange rate changes on the longterm expected income streams,i.e., expectednet wealth of home country stockholders. Thisrisk is usually managed with physicallocation ofassets and liabilities. FOREX-Management of exposure risks

Economic Risk Changes in competitive position as a result of permanent changes in exchangerates. Every company buying or selling abroad or even just competing with foreign companieshas economic risk. Maybach has economic risk from manufacturing its automobiles in Germanyfor export to the United States, where it competes with Rolls Royces manufactured in England.FOREX-Management of exposure risks