Types Of Foreign Exchange Risks

Usually, the most common risk management strategies can be subdivided into multi-stage approach in order to obtain a better impression of the underlying risks and thus to increase the probability of mitigating the firm’s risks properly and successfully. Also General Motors Corporation has developed various rules and guidelines to help manage minimize the risks associated with their business and investment operations.

Effective planning & execution of risk assessment procedure in all financial & operating sectors to identify potential risk to organization.

According to Investopedia, transaction exposure is defined as the risk faced by companies in international trade, that currency exchange rates will change after the companies have already entered into financial obligations. Such exposure to fluctuating exchange rates can lead to major losses for the firm. With this being said, Universal Circuit’s transaction risk is low because its sales invoices are in US dollars and on average, the affiliates pay the Irish branch in fifty five days.

At the end all the risk are finance related, because the liability’s cost money and this will have an effect in the company’s earnings, so what is important is not only to try to avoid such events but also to be prepare in case they happen and have a plan, is like the saying “Hope for the best but be prepare for the worst”.

Risk refers to a likelihood, probability, a chance that a loss may occur in a given organization. Most of the times, there is a high risk when there is vulnerability. In this case, vulnerability refers to a weakness that the organization has. Risk assessment refers to the process of identification of potential hazards and proper analysis of the expected losses if those hazards occur (Homeland Security, n.d.). Risk assessment as a way of profiling risk according to impact to the organization. Some organizations have business impact analysis exercises geared towards determination of potential hazards based risk assessment approaches. Organizations’ risk differ depending on the size and the type of business they are doing. The disparity in organizations’ risk call for different adaptation of risk assessment approaches. Even with the disparities of the businesses, proper risk management not only ranks the risks according to the seriousness but also identifies the best methods to control risks in an organization.

Foreign exchange risk consists of three main types of exposures. First, transaction exposure is when a firm has a contractual obligation under which it supposed to receive or pay a certain amount in a currency that is different than its home currency. Transaction exposure has an effect of the firm’s income statement because the accounts payables or receivables can be affected by currency exchange rates. Second foreign exchange exposure is the translation which impacts the balance sheet of the firm. It occurs when consolidating financial statements of foreign units into a company’s home currency. The third type of foreign exchange exposure is the economic which influences a firm’s cash flows when exchange rates change. This type of exposure can impact assets, liabilities, or any type of anticipated foreign currency cash exchange.

An overall risk profile of the company based on current economic and industry issues that it may be facing.

Risk is an inherent aspect of every business activity and its effective management can determine the success or failure of a company. Companies dealing with foreign currencies are at a risk of significant losses caused by fluctuations in the exchange rates. The American Institute for Foreign Study (AIFS) operates in more than one currency and this exposes it to currency risks. The company incurs its expenses in dollars but receives its revenue in other currencies and, therefore, adverse fluctuations might result in huge losses to the company. The company employs a hedging strategy as its core approach to risk management. Hedging involves entering into contracts that lock up exchange rates in future so that a company obtains its revenues or makes payments in constant exchange rates despite fluctuations. By hedging its currency risks, AIFS is able to avoid losses that result from huge fluctuations in currency exchange rates. However, the company has to pay a commission for the hedging as compensation to entities that assume this risk. AIFS has employed two primary methods of hedging: currency forward contracts and currency options. Forward contracts are agreements that give an entity a right to exchange specified amounts of one currency for another at pre-determined exchange rates in a future date. On the other hand, options give the holder a right but not an obligation to engage in

AIFS is an American based company that offers travel abroad and exchange study services to both college and high school students. While AIFS’s revenues are denominated in American Dollars (USD), most of their costs are in foreign currencies as Euros (EUR) and British Pounds (GBP). Consequently, foreign exchange hedging has a crucial importance for the company because it provides protection against different types of risk that derive from its activity.

The first is transactional risk, which is defined as transactions that lose value due to unfavorable fluctuations of the exchange rate resulting in potential losses for CCE. Our expenses and revenues are not always incurred in the same currencies. We have predetermined profit margin thresholds, and those margins can erode rapidly when the currency we incur our expenses appreciates, or the currency in which we earn our revenue depreciates.

Financial risk is the risk a corporation faces due to its exposure to market factors such as interest rates, foreign exchange rates, commodities and stock prices. Financial risks for the most part, can be hedged due to the existence of large, efficient markets through which these risks can be transferred. This is unlike operating risk, which is associated with more manufacturing and marketing activities. Operating risk cannot be hedged because these risks are not traded.

What is hedging? Hedging is a strategy used to protect risks posed by worldwide currency fluctuations. One hedges the currency risk by contracting to sell foreign currency in the future, at the current exchange rate (Fries). If fund managers think the dollar is going to be stronger when they are ready to change the foreign currency back into American dollars, then they take out a foreign futures contract (a hedge). Thus, they lock in the exchange rate beforehand, so that they will not lose profits gained from holding devalued foreign currency (Hedging, 1999). If the manager guesses correctly, he will boost the fund 's overall return because the profits will be worth even more when they are exchanged into American dollars.

The exchange rate fluctuations brings great deal of uncertainty on profits and costs, hence such risk damages accounting reports, profitability ratings, credit ratings and in the end can bring down the company. There is no question that exchange rate risk has to be managed, and

When done well, the financial, strategic, and operational benefits of hedging can go beyond merely avoiding financial distress by opening up options to preserve and create value. But done poorly, FX hedging can overwhelm the logic behind it and can actually destroy more value than was originally at risk. Perhaps individual business units hedge opposite sides of the same risk, or managers expend too much effort hedging risks that are immaterial to a company’s health. Managers can also underestimate the full costs of hedging or overlook natural hedges, instead applying costly financial ones. Nevertheless, a few simple pointers can help avoid problems and make hedging strategies more effective.

“Measure. In the second stage, armed with a very specific set of political risk scenarios, risk managers assess and quantify the potential impact of each scenario on the business. Discounted cash flow (DCF) analysis can be used, for example, to estimate the financial impact of specific events as an input to help organizations understand their tolerance levels. Other tools, such as an organizational network analysis, can help determine the estimated operational impact of specific risks. Here, risk managers create a model of the company as a network of various inter-dependent business units; for example, a consumer goods company might have manufacturing, packaging and distribution across countries. One of the most important aspects of measurement is the translation of projected events into readily identifiable and comprehensible metrics, such as dollar figures, an impact index, or an ability-to-influence index. Using these metrics, risk managers can assess whether the risk level surpasses the organization’s risk appetite or tolerance.” (Culp, Steve)