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Exchange Rate Risk

Exchange Rate Risk (also Currency Risk) is the uncertainty of the future development of one currency in relation to another. Exchange rate risk refers to the potential to lose money because of a change in the exchange rate. To minimize the exchange rate risk the costs for transactions for all parties, contractor, investor and consumer will raise. Especially for international business transactions there is a big influence. Exchange Rate Risk is higher the more forward in the future the planed payment will be and the higher the volatile between two currencies is. Especially in B2B this is the case. The timing depends also on the payment option. (Classic Payment vs. digital payment) It has to differentiated between different types of risk and different ways to handle them.

Different types of exchange risk

1. Translation risk

Translation risk is the risk which is shown in the balance sheet of a company. the risk is from different subsidiaries of a company. E.g. BMW has an subsidiary in China. The assets from China will be different in the BMW balance sheet every year depending on the exchange rate EUR/RMB

2. Transaction risk

Transaction risk is based on deals and long time cash flows. The impact of the currency used in the contracts for receivables (export business) and payables (import business). The result is a direct exchange risk transaction.

3. Economic risk

Is the future development of the business in dependency of the exchange rate movements. It is the difference of operating expenses and revenues. It is the present value of a future cash flows operations of a company.

The measurement of exchange risk

It`s important to measure exchange rate risk and manage the exposure to reduce the firm’s vulnerabilities major movements of the exchange rate, as this would which could negatively influence the profitability and the company value. The main types of exchange risk companies have to face are translation, transaction, and economic risks. The most used method to measure exchange rate risk it the VaR approach. TheVaR (Value at Risk) is calculated as VaR= -Vp (Mp + 2.33 Sp) Companies differentiate between strategically and tactical and active and passive hedging of exchange risk.

Impact on consumer behavior

Beside the risk for investors and companies on a long term perspective exchange rate risk can also have an positive impact on the economy and international trades. Especially for consumers (B2C Commerce) how do not plane investment for the future can use the benefit from the difference of two currencies. Thanks to the strong growth of e-business via Internet and new ways of logistics allow consumers to order products around the world. The most famous examples for virtual marketplaces might be ebay and amazone.

Example: A Porsche will cost 80.000 Euro in Germany. The same Porsche is available in America for 100.000 USD. As the consumer has to pay in USD he has to change EUR – USD which is with an exchange rate of 1,43 EUR/USD approx. 70.000 EUR. So the consumer can save 10.000 EUR. The seller has no exchange risk as he gets the money in USD. In case he would have offered the Porsche in EUR, e.g. 70.000 he would have the risk of exchange risk from the point of sale until he changes the EUR into USD. If on the day when he receives the money the exchange rate is higher lower e.g. 1,30 EUR/USD he will only receive 91.000 USD and loss 9.000 USD. To reduce the risk he can use different vehicles to fix the exchange rate. The most used is a currency swap.

To sum up, on a consumer perspective the exchange rate risk is only given when he has to pay in a currency on a later point of time than on the POS. When he pays in his “home” currency the risk is with the seller; anyway the seller will put the price to reduce the risk on top of the price.

<note tip> To see weather a product might be ceaper in an other currency use Currency Calculator </note>

Resources

Actual Informations

Exchange Rate Overview: UniCredit Research

Actual Informations: Finance Trainer

Journals:
Theory:

Ertragsorientiertes Bankmanagement; Band 2; 6. Auflage, Seite 134.

Mundell, Robert A. (2000): Threat to Prosperity, in: Wall Street Journal/ Eastern Edition, Band 235

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international/exchange_rate_risk.txt · Last modified: 2011/09/09 23:11 (external edit)