Question

Types of exchange rate risk include all of the following, except:

Answer 1

Transaction Risk:- It occurs when a company buys products or services in a different currency or has receivables in a different currency than their operating currency. Since the payables or receivables are denominated in a different currency, the exchange rate at the initiation of a transaction and on the date of settlement may have changed due to the volatile nature of the forex market. This can cause a gain or loss for the company depending on the direction of the movement of exchange rates and thus poses risk to the company.

Translation risk:- It occurs when a company’s financial statement reporting is affected by the exchange rate volatility. A large multinational generally has a presence in many countries and each subsidiary reports their financial statements in the currency of the country in which they operate. The parent company generally reports the consolidated financials and this involves translating foreign currencies of different subsidiaries to the domestic currency. And this can have a huge impact on the company’s balance sheet and income statement and can ultimately affect the stock price of the company.

Economic Risk:- A company faces economic risk when the volatility in the exchange rate market can cause changes in the market value of the company. It basically represents the effects of exchange rates movement on revenues and expenses of a company which ultimately affects the future operating cash flows of the company and its present value.