NATURE OF CURRENCY RISK

sunandaC

New member
Currency risk or exchange rate risk arises in buying, selling, investing and borrowing. Therefore, it is essential to recognize the nature of currency risk and how they arise in business.

1) RISKS IN SELLING ABROAD:

A company selling goods or services abroad faces currency risk, regardless of whether its sales are priced in its domestic currency or in a foreign currency.
For e.g. suppose that a UK Company sells goods to foreign buyers.

Sales priced in sterling: If sterling strengthens, prices to foreign buyers in their domestic currency will rise. Demand will fall to an extent that will depend on the strength, or elasticity, of demand for the product. Falling sales will reduce total profits.

Sales priced in a foreign currency: If exports are priced in a currency that falls in value against sterling, the company’s sterling earnings will fall. Profit margins also will fall. The company either must accept the lower profits margins or raise prices. Higher prices could result in lower sales demand and lower profits.

2) RISKS IN BUYING FROM ABROAD

A company buying goods from abroad might be invoiced in its domestic currency, but is more likely to be invoiced in a foreign currency.

For e.g. suppose that a US company buys a range of goods from foreign suppliers.
Purchases invoiced in dollars: If the dollars weakens, foreign suppliers are likely to raise their dollar prices so that profits in their own currency can be maintained.

Costs of purchases therefore will rise. Purchases invoiced in a foreign currency: If the dollar weakens, it will cost the company more in dollars to buy the foreign currency to pay for the goods. Costs of purchases will rise.

3) RISKS FROM INVESTING ABROAD

The profits of a parent company’s foreign subsidiary, as reported in the parent company’s domestic currency, will fall if the subsidiary’s domestic currency weakens in the value against the parent company’s domestic currency. As a result multinational companies with foreign subsidiaries have constant exposure to currency risk. The value of a foreign investment will fall if the currency in which it is denominated weakens against the investor’s domestic currency.

4) RISK FROM BORROWING IN A FOREIGN CURRENCY

Exchange rate movements, as well as interest rates, affect the cost of borrowing in a foreign currency. The cost of a foreign currency loan will rise or fall if the borrower’s domestic currency weakens or strengthens against the currency in which the loan is denominated.
Currency risk would be reduced if either

 The volatility in exchange rate movements were lessened and exchange rates fairly stable, or

 Future exchange rate movements could be predicted with reasonable accuracy.

Currency Risk depends on the regularity and size of exchange rate movements. An exposure to currency risk is greater when the exchange rate could change by a larger percentage amount, i.e. when exchange rate volatility is high. Changes that might occur in the future can be estimated from changes that have occurred in the past.
 

rosemarry2

MP Guru
Currency risk or exchange rate risk arises in buying, selling, investing and borrowing. Therefore, it is essential to recognize the nature of currency risk and how they arise in business.

1) RISKS IN SELLING ABROAD:

A company selling goods or services abroad faces currency risk, regardless of whether its sales are priced in its domestic currency or in a foreign currency.
For e.g. suppose that a UK Company sells goods to foreign buyers.

Sales priced in sterling: If sterling strengthens, prices to foreign buyers in their domestic currency will rise. Demand will fall to an extent that will depend on the strength, or elasticity, of demand for the product. Falling sales will reduce total profits.

Sales priced in a foreign currency: If exports are priced in a currency that falls in value against sterling, the company’s sterling earnings will fall. Profit margins also will fall. The company either must accept the lower profits margins or raise prices. Higher prices could result in lower sales demand and lower profits.

2) RISKS IN BUYING FROM ABROAD

A company buying goods from abroad might be invoiced in its domestic currency, but is more likely to be invoiced in a foreign currency.

For e.g. suppose that a US company buys a range of goods from foreign suppliers.
Purchases invoiced in dollars: If the dollars weakens, foreign suppliers are likely to raise their dollar prices so that profits in their own currency can be maintained.

Costs of purchases therefore will rise. Purchases invoiced in a foreign currency: If the dollar weakens, it will cost the company more in dollars to buy the foreign currency to pay for the goods. Costs of purchases will rise.

3) RISKS FROM INVESTING ABROAD

The profits of a parent company’s foreign subsidiary, as reported in the parent company’s domestic currency, will fall if the subsidiary’s domestic currency weakens in the value against the parent company’s domestic currency. As a result multinational companies with foreign subsidiaries have constant exposure to currency risk. The value of a foreign investment will fall if the currency in which it is denominated weakens against the investor’s domestic currency.

4) RISK FROM BORROWING IN A FOREIGN CURRENCY

Exchange rate movements, as well as interest rates, affect the cost of borrowing in a foreign currency. The cost of a foreign currency loan will rise or fall if the borrower’s domestic currency weakens or strengthens against the currency in which the loan is denominated.
Currency risk would be reduced if either

 The volatility in exchange rate movements were lessened and exchange rates fairly stable, or

 Future exchange rate movements could be predicted with reasonable accuracy.

Currency Risk depends on the regularity and size of exchange rate movements. An exposure to currency risk is greater when the exchange rate could change by a larger percentage amount, i.e. when exchange rate volatility is high. Changes that might occur in the future can be estimated from changes that have occurred in the past.

hey friend,

Please check attachment for Research Study on Currency Risk Management Practices of Canadian Firms, so please download and check it.
 

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