Exchange Risk

8/2/2019 Exchange Risk

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BY- MONIKA SOOD

JITENDRA SINGH


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INTRODUCTION

Foreign exchange risk is the

possibility of a gain or loss to a

firm that occurs due tounanticipated changes in

exchange rate.


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EXCHANGE RISK IS

DIVERSIFIABLE.


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TYPES

TYPES OF EXPOSURE

TRANSLATIONTRANSACTIO

NECONOMIC


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TRANSLATION EXPOSURE

It is the degree to which a firm`s

currency denominated financial

statements are affected by exchangerate changes.

It is also called accounting exposure.


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TYPES

Current rate method

Current/non-current method

Monetary/non-monetary method

Temporal method


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Current rate method

All items of balance sheet and

income statement are translated

at current rate or post changerate.


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Merit of this method is that the relative

proportion of individual balance sheet

accounts remains the same and the process

does not distort various balance sheet ratios.

Demerit is that the fixed assets are also

translated at current rate that goes against the

principles of accounting.


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Current/ non current method

Only current assets and current liabilities

are translated at current rate or post

change rate but the fixed assets and longterm liabilities are translated at historical

rate.


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Demerit of this method is that the

long term debts which is also

exposed to exchange rate change isignored by this method.


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Monetary/ non-monetary method

Items that represent a claim to receive come

under monetary group whereas physical

assets and liabilities come under non-

monetary group.

Monetary assets and liabilities are translated

at current rate while non-monetary assets and

liabilities are translated at historical rate.


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Temporal method

Historical cost items are translated at historical

rate while items that are related to replacement

cost ,market value are translated at current rate.

This method resembles the monetary/non-monetary method only the difference is that in

temporal method inventory is translated at

current rate if it is shown at market value but informer the inventory is always translated at

historical rates.


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ECONOMIC EXPOSURE

It refers to the degree to which a firm`s

present value future cash flows can be

influenced by exchange rate fluctuations. Hence, this exposure affects the

profitability of the company over a longer

time span than translation or transactionexposure.


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Economic exposure cannot be

hedged while both transaction and

translation exposure can be hedged.


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TRANSACTION EXPOSURE

It refers to the extent to which the

future value of firm`s domestic cash

flow is affected by exchange ratefluctuations.


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Documents

Exchange Risk