12 Foreign Exchange Risk Management: Answer
12 Foreign Exchange Risk Management: Answer
12 Foreign Exchange Risk Management: Answer
Question No. – 9
[CMA-Dec-2002-Old-4M] [CMA-Dec-2004-Old-8M] [CMA-June-2006-Old-7M]
“Operations in foreign exchange market are exposed to a number of risks.” Discuss.
[Nov-2007-3M] [May-2016-4M]
OR,
Briefly explain the major types of currency exposures.
OR,
What do you understand by Foreign Exchange Risk? State the different types of Foreign Exchange
exposure?
OR,
What are the risks to which foreign exchange transactions are exposed? [Nov-2014-4M]
Answer
A firm dealing with foreign exchange may be exposed to foreign currency exposures. The exposure
is the result of possession of assets and liabilities and transactions denominated in foreign currency.
When exchange rate fluctuates, assets, liabilities, revenues, expenses that have been expressed in
foreign currency will result in either foreign exchange gain or loss. A firm dealing with foreign
exchange may be exposed to the following types of risks:
(i) Transaction Exposure: A firm may have some contractually fixed payments and receipts in
foreign currency, such as, import payables, export receivables, interest payable on foreign
currency loans etc. All such items are to be settled in a foreign currency. Unexpected fluctuation
in exchange rate will have favourable or adverse impact on its cash flows. Such exposures are
termed as transactions exposures.
(ii) Translation Exposure: The translation exposure is also called accounting exposure or balance
sheet exposure. It is basically the exposure on the assets and liabilities shown in the balance sheet
and which are not going to be liquidated in the near future. It refers to the probability of loss that
the firm may have to face because of decrease in value of assets due to devaluation of a foreign
(iii) Economic Exposure: Economic exposure measures the probability that fluctuations in foreign
exchange rate will affect the value of the firm. The intrinsic value of a firm is calculated by
discounting the expected future cash flows with appropriate discounting rate. The risk involved
in economic exposure requires measurement of the effect of fluctuations in exchange rate on
different future cash flows.