Foreign exchange risk exposure primarily refers to the financial insecurity or risk that is associated with a transaction that is denominated in a currency which is different from the base currency of the company. Foreign exchange risk is also commonly known as exchange rate risk, FX risk or currency risk which arises from a case where a subsidiary firm of a multi-national company prepares and keeps its books of accounts in a currency which is not the currency in which the consolidated books of accounts of the multi-national are made. Hence, when such a financial document or statement is converted to the base currency or the domestic currency of the multi-national firm for the purpose of preparing consolidated accounts it gives rise to risk related to foreign exchange.
The basic fundamental that forms the foundation of this exposure is the fact that currencies are extremely liquid and the rates of exchange are dynamic and volatile. The rates of exchange keep fluctuating every minute which creates an impact on the transactions that are associated with exchange rates and currencies and this causes risk and financial exposure. Businessmen, Banks, financial institutions, investors, traders and other parties that participate in the foreign exchange market can’t avoid or stay away from the risk involved in this dynamic market. However, there are certain techniques and strategies that can be used to analyze, measure and tackle the risk involved in foreign exchange market. There are various types of foreign exchange market risks and exposures that are faced by participants in everyday trading in the market.
Types of foreign exchange risk & exposures
The various types of risks and exposures in Foreign Exchange Markets that are encountered by the firms and other participants are:
Transaction risk is a simple and hence the most frequent form of exposure that can be faced and experienced in the foreign exchange market. Transaction risk is basically the risk associated with the transacting process of business in terms of currency other than domestic currency i.e. foreign currency.
Another type of exposure in the foreign exchange market is economic exposure. It is also commonly referred to as forecast risk. It is basically the degree of a firm’s market value that is affected by unforeseen exchange rate dynamics. These factors can have a huge impact on the market position of the firm, the future cash flows and the value of the firm. Risks like economic risk are not specifically associated with foreign exchange market alone, a firm can be exposed to economic risks due to plenty of other reasons and factors.
Translation risk is basically the risk that is linked to the translation of a subsidiary’s financial statement in a currency alien to the domestic currency of the multi-national company. Domestic currency here refers to the currency in which the consolidated accounts of the MNC are prepared. The translation of financial records may be affected by the exchange rates and their fluctuations of the currencies involved. Such risk can however be nullified and doesn’t require much of management’s attention.
Contingency is associated with doubt. A contingent situation is a situation which may or may not arise. Contingent risk thus depends upon an event which might or might not take place.
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24 Feb 2020 05:08 PM
When they say the currency markets are volatile, it is the spot exchange rate, which is being referred to, which fluctuates within seconds.
07 Feb 2020 03:19 PM
Derivatives market enables access to financial assets for trading at a future date and not just at the market trading date. In currency derivatives the trader agrees to buy or sell a fixed amount of a specified currency at the end.
27 Jan 2020 02:13 PM
Well devaluing a currency can give a thrust to the exports and reduce the trade deficit but for any economy which has higher imports, the consequences can be on the negative too.
16 Jan 2020 05:08 PM
Pegged exchange rate is the fixed rate at which the currency is converted from one to another. The rate is fixed by the monetary authority to order to stabilize the rate of exchange at a predetermined ratio of another currency which is more stable an
10 Jan 2020 06:00 PM
As markets are technology driven, the rise in foreign exchange transaction has done at the touch of a button making it the largest financial market in terms of volume.
03 Jan 2020 04:24 PM
Foreign exchange volatility is what drives the currency market and higher volumes are seen during the high volatile days. In the global foreign exchange market there are unpredictable movements of foreign exchange rates.