Question

200 Words Response

Discuss different modes of currency risk and how each should be managed.

Answer 1

---> currency risk are risks arising from changing price of one currency as compared to another currency. Whenever companies or investors possess assets across national boundaries, they experience currency risk if their positions are not prevaricated. Currency risk is also called exchange rate risk. So currency risk is defined as the possibility that currency depreciation will show negative effect on the value of assets, investments etc.

-->There are 2 basic types of currency risks:-

-->Transaction risk:- relating to unfavorable foreign exchange rate over a period of time.

-->Translation risk:-- It is relative to the amount of assets held in foreign currencies. Alterations in exchange rate over a certain period will provide an inaccurate report, and thus the assets are generally balanced by borrowings in the specific currency.

-->These risks are managed by using various tools. Transaction exposure can be reduced either with the use of money markets, foreign exchange derivatives such as forward contracts, options, futures contracts,swaps etc.Firms can manage translation exposure by performing a balance sheet hedge, since translation exposure arises from discrepancies between net assets and net liabilities from exchange rate differences.