Question

QUESTION 2 a. Foreign exchange risk or exchange rate risk is a financial risk that occurs when a financial deal is denominated in a currency other than that of the base currency of the company. Explain the following types of risks that international firms are exposed to: a. Transaction risk b. Translation risk c. Economic risk b. For each of the risks explained above, state three (3) ways of mitigating them.

Answer 1

Answer>

Transaction risk - It refers to the risk that foreign exchange rate fluctuations could have on a pending transaction prior to its completion. It is a type of exchange rate risk due to time delay in entering a contract and settling it.

Translation risk - It refers to the risk involving change in the fair value of a company's equities, assets, liabilities, or income due to changes in exchange rate values. This occurs when the companies assets, equities, liabilities or income are denominated in other currency.

Economic risk - It refers to the risk on investments done by a company in other countries due to changes in exchange rates from government regulations, political stability and other macroeconomic factors.

Three ways to mitigate these risks -

Transaction risk -

a> By making contracts which have fixed value of exchange rates.

b> By using hedging tools like futures and options

c> By reducing the time to settle a transaction

Translation risk -

a> By using hedging tools like futures and options

b> Using effective cost accounting to incorporate this risk in the accounts

c> By reducing the unnecessary exposures, wherever possible

Economic risk -

a> by investing in insurance policies

b> By using hedging tools like futures and options

c> By investing in international mutual funds

Hope this answers your question