For WizardKim-DP3
Week 6 Discussion Post 2nd Response:
Instructions: Respond to the post below from your fellow classmate. Any opinions, or anything you would like to add to discuss about their post. Must be three substantial paragraphs, and three references.
Foreign exchange transactions and a trade in which the currency of one country is exchanged for that of another. Most international transactions are carried out using a set of currencies, including the US dollar. Frequently, fluctuations in exchange rates are one of the causes that most collaborate to compromise the profit of organizations in transactions in foreign trade. This is due to the lack of necessary understanding of currency risk.
Many managers do not have the essential understanding of currency risk and, without proper management, these fees can lead to losses. In this way, good management and strategic planning can reduce risks and also contribute to the success of the company's international negotiations.
First, exchange rate risk consists of uncertainty regarding the currency's value as a result of fluctuations in the exchange rate. Therefore, it can be understood as the probability that the exchange rates between the currencies of the exporting countries will move in the opposite direction, between the quotation date and the settlement date of a trade. Exchange rate risk management is an integral part in every firm’s decisions about foreign currency exposure Exchange rate risk management is an integral part of every company’s decisions about foreign exchange exposure (Allayannis, Ihrig, and Weston, 2001).
To measure exchange rate impacts, it is necessary to identify the types of risks to which companies are exposed:
1. Transaction Exposure - It is the risk that exchange rate fluctuations will change the value of a contract prior to its settlement (The strategic CFO). Weights the risks associated with each particular market and the possibility of an operation not going as desired, which is basically the cash flow risk and deals with the effect of the exchange rate moving on the exposure of the transactional account related to receivables (export contracts), accounts payable (import contracts) or repatriation of dividends. A change in the exchange rate in the currency of denomination of any contract will result in a direct exchange rate risk transaction for the company (Michael Papaionnou);
2. Translation Exposure - Shows the potential for change in the parent company's net worth and reported net income. The translation activity is performed due to the reporting of books to shareholders or legal bodies.
Translation Exposure analyzes the possibility of rate variation in the trading period to get a sense of its coverage, which is basically the exchange rate risk of the balance sheet and is related to the exchange rate moves for the valuation of a foreign subsidiary and, for in turn, for the consolidation of a foreign subsidiary in the parent company's balance sheet. Translation risk for a foreign subsidiary is usually measured by the exposure of liquid assets (assets less liabilities) to potential exchange rate movements. (Michael Papaionnou)
3. Economic exposure is the extent to which the value of the firm would be affected by unexpectedchanges in currency exchange rates. The purpose of this exposure to analysis changes in exchange rates that effect the firm’s operations and competitive advantage or disadvantage against other firms
It is worth remembering that exchange rate risk is the common and natural result of the relations established between companies of different currencies.
References:
Allayannis, G., J. Ihrig, and J. Weston, 2001, “Exchange-Rate Hedging: Financial vs. Operational Strategies,” American Economic Review Papers and Proceedings, Vol. 91 (2), pp. 391–395.
The strategic CFO. Transaction Exposure definition. https://strategiccfo.com/transaction-exposure/
Michael Papaioannou.(2006).Exchange Rate Risk Measurement and Management: Issues and Approaches for Firms. https://www.imf.org/external/pubs/ft/wp/2006/wp06255.pdf