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Foreign Currency Risk

In: Business and Management

Submitted By monkeyman88
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FOREIGN CURRENCY RISK EVALUATION
ACC401

With Firm XYZ’s proposed expansion into three new foreign markets there will be several problems that arise. A risk assessment will need to be completed and presented to the board. The following is a risk assessment, with relevant subsequent mitigation measures in the area of foreign currency.
Types of Risk
There are primarily three types of risk that the firm XYZ faces with the expansion abroad. These are the accounting exposure, transaction exposure and the operating exposure. Accounting exposure, is defined as the exposure that a company faces due to the reduction of its value; as a result of foreign exchange differences between the currency used in the main branch and the currency used in the other country (Gertler, Kiyotaki and Queralto, 2012). Accounting exposure is also referenced as translation exposure. The item most affected by this risk is the balance sheet. This is because the balance sheet is the statement which shows the net worth of a company.
Transaction exposure is the risk that a company involved in international trade might incur. Upon entering into an agreement, a company may have to pay higher costs to meet those financial obligations as a result of changes in the foreign exchange. Unlike economic exposure, transaction exposure is well-defined and short-term. Transaction exposure is simply the amount of foreign currency that is receivable or payable. Operating exposure is the risk that a firm with a foreign subsidiary faces when meeting expenses in the foreign country as a result of unexpected changes in the foreign exchange rate.

Mitigation of Exposure
To mitigate the risk associated with each type of exposure, several options are available to the CEO. One of the strategies is the balance sheet hedge. This is usually applied with accounting exposure. Hull (2012) defines the balance...

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