exchange rate

Topics: Foreign exchange market, Exchange rate, Purchasing power parity Pages: 10 (3479 words) Published: April 27, 2015
1. Issue one: Foreign exchange risk and economic implication In the context of international trade and integration, multinational companies have a lot of opportunities to expand and make profits but they are also likely to face new challenges. One of the most risks such firms need to be recognized is foreign exchange exposure which is directly related to foreign exchange rate.

1.1. Possible foreign exchange risk
In order to have a comprehensive view regarding foreign exchange risk, this part will define as well as separate this exposure into clearer and smaller concepts. Firstly, it is highlighted to indicate that foreign exchange exposure possibly occurs as a result of the fluctuation of exchange rates, leading to negative effects on profitability, cash flows and other financial indicators of multinational companies. In this case, managers will find more difficult to manage and run their companies and the need to measure such exposures becomes very necessary. Therefore, with the purpose of clarifying and measuring foreign exchange risks, it is separated into three common kinds including transaction, economic and translation exposure. Besides that, based on empirical researches, tax exposure in spite of happening seldom, is also discussed in this paper. The following figure will reveal clear separation of foreign exchange risk:

In particular, the first concept expressed is transaction exposure which is associated with fluctuation of actual cash flows out of the value they should be. In other words, contractual obligations in the future are likely to take transaction risk, resulting in the depreciation of value of payment currency. Normally, transactions relating to receivables and payables of multinational companies are relevant popular examples in this case. In addition, buying foreign bonds or getting involved investments denominated in foreign money is likely to suffer from transaction exposure. Taking into account the second type, economic exposure, the horizon is undecided. With this case, it is unpredicted effects of fluctuations of exchange rates on operating cash flows in the future, leading to the variation of company’s present value. As a result, other measures of the company such as future costs, sale volume and price are also affected. In comparison with the transaction exposure, economic exposure primarily measures variation of expected future cash flows instead of those bonded by contractual obligations. To be extent, economic exposure is also considered as competitive, operating or strategic exposure. The third type of risk separated is the translation exposure which is the same as accounting exposure. To be explained, it takes the accounting view in the context of the ups and downs of the foreign exchange rates. Following that, subsidiaries which financial reporting is implemented in foreign currency are likely to influence consolidate statement of their parent company. In this case, the translation to match financial statements has to take risks derived from the unrest of the foreign exchange rate. To be further discussed, with multinational companies, owning to the difference of taxation policies, the tax exposure is also an issue need to be considered. By scrutinizing this type of risk, financial managers can better control after-tax results with the pursue of maximizing gains and minimizing losses.
According to Marshall (1999), it is argued that the most outstanding foreign exchange risk is transaction exposure with the statistics collected from multinational companies in United Kingdom, United State of America or Asia Pacific. It seems to be that the main factor affecting the transaction risk is comparative power of the currency reported in company’s financial statement rather than others such as the counties, company size or industry sectors. Besides that, economic exposure, because of the difficulty in quantifying relevant risks, is also important. Theoretically, this type should...
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