Question

1. Four main schools of thought exist as to the relevance of exchange rate risk. The Multinational Corporation's treatment of exchange rate risk is a result of their thoughts on exchange rate risk. Discuss the thoughts surrounding exchange rate risks and the MNC's response to these arguments.

Answer 1

There are different types of exchange risks. They generally depend on the nature of the business of an organisation.

They can be categorized as:

1.Transaction Risk:

Generally, organisations deal in exports and imports face this kind of forex exposure. If we are exporting to a foreign country and our home currency drops when compared to that other country, our export value will increase. We will receive higher amount in our home currency. Similarly, drop in home currency will increase outgoing payments for Imports.

2. Translation Risk:

When our organisation financial statements are translated into other currencies for any reasons, due to exchange rate fluctuations, our balance sheet values may change. The firm may face problems if the value of assets fluctuates. This risk may arise though there are no transactions during the year.

3.Economic Exposure:

Exchange rate fluctuations may change the intrinsic value of the firm. Intrinsic value is calculated by discounting future cash flows from the firm. While calculating the cash flows we need to consider the economic exposure for estimating fluctuations for future cash flows.

Foreign exchange risk can be kept at a minimum by effective planning. There are many tools to do this. Following may be some good ideas:

1. Forward Contracts

2. Future Contracts

3. Forex Options

4. Currency Swaps

5. Hedged Exchange Traded Funds