The recognition of the financial risks associated with foreign exchange mean some decisions need to be made. The key to any good management is a rational approach to decision making. The most desirable method of management is the pre-planning of responses to movements in what are generally volatile markets so that emotions are dispensed with and previous careful planning is relied upon.
This approach helps eliminate the panic factor as all outcomes have been considered including 'worst case scenarios', which could result from either action or inaction. However even though the worst case scenarios are considered and plans ensure that even the 'worst case scenarios' are acceptable (although not desirable), the pre-planning focuses on achieving the best result.
Most Business are exposed to currency risk, even a local producer for a local market often will be threatened by cheap foreign imports, a form of indirect economic exposure.
The potential costs and benefits of exposures can be assessed quite easily, provided the exposures have been quantified. This assessment calls for a simple judgment about the possible change in the relevant exchange rate. Transaction exposures and translation exposures should be analyzed separately.
E.G. A US company owns a Dutch subsidiary that has a net asset value of € 20million and earns annual profits of € 3 million. The current exchange rate is €1=$ 1.08.
Translated into dollars at the current exchange rate, the value of the company’s net assets is $21.6 million; the annual profits are $3.24 million (3*1.08).A 5% movement in the exchange rate ,up or down, would result in the dollar value of the net assets changing by $1,080,000 and reported annual profits changing by $162,000.
This approach helps eliminate the panic factor as all outcomes have been considered including 'worst case scenarios', which could result from either action or inaction. However even though the worst case scenarios are considered and plans ensure that even the 'worst case scenarios' are acceptable (although not desirable), the pre-planning focuses on achieving the best result.
Most Business are exposed to currency risk, even a local producer for a local market often will be threatened by cheap foreign imports, a form of indirect economic exposure.
The potential costs and benefits of exposures can be assessed quite easily, provided the exposures have been quantified. This assessment calls for a simple judgment about the possible change in the relevant exchange rate. Transaction exposures and translation exposures should be analyzed separately.
E.G. A US company owns a Dutch subsidiary that has a net asset value of € 20million and earns annual profits of € 3 million. The current exchange rate is €1=$ 1.08.
Translated into dollars at the current exchange rate, the value of the company’s net assets is $21.6 million; the annual profits are $3.24 million (3*1.08).A 5% movement in the exchange rate ,up or down, would result in the dollar value of the net assets changing by $1,080,000 and reported annual profits changing by $162,000.