Currency Exchange Rate Risks

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Presentation transcript:

Currency Exchange Rate Risks Hedging Currency Exchange Rate Risks

Currency Exchange Risk Cash Inflow in one Currency is Higher or Lower than Corresponding Cash Outflow in Different Currency = Currency Exchange Rate Risk

Types of Currency Exposure Transaction exposure: Occurs when a one time contract is denominated in a foreign currency (example: GM buys a new machine in Germany for Detroit factory) Translation exposure: Occurs when of financial statements must be consolidated Operating (Economic) exposure: Occurs when cash inflow (outflow) exceeds cash outflow (inflow) in a different currency as a result of ongoing business activities (example: GM exports cars produced in Detroit to Canada)

Hedging Currency Exchange Risk 1. Short Term Hedging ( 18 Month) Transaction Exposure Lock in Currency Exchange Rate through the Use of Financial Instruments - Forward Contract - Futures Contract - Option Contract

2. Long Term Hedging Close Gap of Cash Flows in Different Currencies Direct Investment Finance Operation in Foreign Currency Financial Instruments Can only Eliminate Short Term Fluctuations, They Can NOT Eliminate the Currency Exchange Rate Risk for Ongoing Business Operations (operating exposure).