Essay About Fluctuation Of The Rateseconomic Risk And Firm’S Future

Exchange Rate Risk
Exchange rate risk Transaction risk:Accrues when:- purchasing/selling goods at previously agreed prices- borrowing/lending funds in foreign currenciesHow much the income from individual transaction is affected by fluctuation of the ratesEconomic risk:Firm’s future of international earning affected by changes in exchange ratesLong term effect of changes in rates → different pricesTranslation (Accounting) risk:Impact of exchange rate changes on financial statements of a companyConcerned with present measurement of past eventsGains/losses are unrealized = paper lossesHedging:Operating hedge:Cash management along a company through intracompany accountsPossibilities:Reduce cash to a minimum by purchasing inventories or other assetsTry to delay payments (extended trade credit)Avoid giving extended trade creditBorrow the local currencyMeaning in examples:Cash netting of obligations among units (same currency) The bigger the hedged amount the “cheaper” (per unit) it is to hedgeFinancial hedge:       Derivate securities:Traded on spot market, prices set by forces of demand and supplyCan hedge risk, but can also give more riskForward contracts:Agreement to trade at a specified price a specified quantity on a specified place on a specified date in the futureOn maturity date the buyer takes delivery, the seller receive agreed paymentAmount will be paid regardless of the actual spot exchange rate on the date of maturity→ More flexibleFuture contracts:       Same as futures but:Traded on organized exchangesHighly standardized Highly traded volumes → good liquidity Can only be concluded for delivery in pre-specified months (usually 4years)Guaranteed by stock exchanges → lower risk, ease of tradeShort future hedge: selling a future contract, when you make delivery of an asset at a future date → minimize risk of a drop in priceLong future hedge: buying a future contract, used when buying an asset at a future date → minimize the risk of a increasing priceSwaps:       Exchange one financial contract for anotherInterest-rate swaps: convert an asset held at a floating rate of interest to a fixe rate and backward → Change of interest flows, no change of principalCurrency swaps: exchange debt obligations in different currencies, each agrees to pay the other’s interest obligation → Only cash-flow differences are paid, no exchange of principal