Topics: Foreign exchange market, Exchange rate, Currency Pages: 4 (1302 words) Published: March 9, 2014
Question 1
The rapid growth in the international trade has also increased the risk of exchange rate uncertainty for the various firms, specially involved in the international business. As compared to other macroeconomic factors like interest rate and inflation rate, foreign exchange rate exposure is four times and ten times as volatile as interest rate and inflation rate respectively (Jorion, 1990). This type of risk has forced the firms to pay more attention to the effect of exchange rate exposure on the firm transactions and its value. Exchange rate exposure can affect the value of firm’s assets and liabilities that are denominated in the foreign currencies. Therefore, exchange rate movement also affects the stock price of the firm (Chen, Naylor and Lu, 2004). Transaction based exchange rate exposure affect the competitive position, the inputs and outputs, the supply and demand chains of the international firms. Transaction based exposure is the type of exchange rate risk that exists when firms engaged in the financial obligations due to be settled in foreign currencies. For example, a company that conduct import and export business may be due to be paid foreign currency in next 3 months for some goods exported. When they will receive the payment, they have to convert the foreign currency into their local currency. If during these three months, the value of local currency becomes stronger against the foreign currency, then the firm will receive fewer amounts as compared to previously payment. This type of risk is called transaction based risk and it can only be minimize by managing the exchange rate exposure utilizing any of a large choice of alternatives. The most important solution used by the firms is to make sure that this type of exposure is not created in the first place. Most of the firms in South East Asian regions are using the method of billing the foreign customer in home currency. By doing this they are transferring the risk of exchange rate...
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