What is Foreign Exchange Rate Risk

Summary

This video discusses the risks businesses face from foreign exchange rate fluctuations. It covers three primary types of risks: transaction risk, consolidation risk, and economic risk. Transaction risk relates to short-term trading and cash flow movements, while consolidation risk concerns the conversion of foreign assets and liabilities into local currency. Economic risk is long-term, such as with foreign currency borrowings. The video also highlights how these risks can be managed, including through hedging. Finally, the host, Shakti Ramto, encourages viewers to like and subscribe for more finance and accounting content.

Takeaways

• 😀 Foreign exchange rate risks affect businesses involved in international trade, such as those buying raw materials from abroad.
• 😀 A manufacturing company might need to pay in dollars for imports while its local currency is in rupees, exposing it to exchange rate risks.
• 😀 Foreign exchange rate risks manifest in three forms: transaction risk, consolidation risk, and economic risk.
• 😀 Transaction risk is short-term and relates to cash flow movements, such as the purchase of raw materials.
• 😀 Hedging can be used to reduce or eliminate transaction risk in businesses dealing with foreign exchange.
• 😀 Consolidation risk refers to the need for a company to convert foreign assets and liabilities into its local currency for reporting purposes.
• 😀 Unlike transaction risk, consolidation risk does not involve cash flow movement but is important for financial reporting.
• 😀 Economic risk is long-term in nature and typically involves issues like long-term borrowing in foreign currencies.
• 😀 A key example of economic risk is when a company borrows money in a foreign currency and faces challenges due to exchange rate fluctuations.
• 😀 Hedging is difficult for economic risk, especially when it comes to long-term borrowing in foreign currencies.
• 😀 The video is hosted by Shakti Ramto, who encourages viewers to like and subscribe for more videos on accounting and finance.

Q & A

What is the main topic discussed in the video?

The video discusses businesses facing foreign exchange rate risks, specifically how these risks impact companies involved in international trade.

What is transaction risk in the context of foreign exchange rate risks?

Transaction risk refers to the short-term risk associated with cash flow movements, particularly in situations where a company purchases raw materials from abroad and has to pay in a foreign currency, while its local currency is different.

How can transaction risk be managed or reduced?

Transaction risk can be reduced or eliminated through hedging, which involves using financial instruments to protect against fluctuating exchange rates.

What is consolidation risk?

Consolidation risk, also known as translation risk, occurs when a company needs to convert its foreign assets and liabilities into its local currency. This does not involve cash flow movement but can affect financial reporting.

Does consolidation risk involve cash flow movement?

No, consolidation risk does not involve cash flow movement. It is purely related to the conversion of foreign assets and liabilities into the local currency.

What is economic risk in terms of foreign exchange?

Economic risk is a long-term risk that arises from factors such as long-term foreign currency borrowings. It is difficult to hedge and can affect a company’s overall financial stability over time.

Can economic risk be easily hedged?

No, economic risk is difficult to hedge, especially when it involves long-term foreign currency borrowings.

How is transaction risk different from economic risk?

Transaction risk is short-term in nature and involves cash flow movements, whereas economic risk is long-term and related to broader financial decisions, such as long-term borrowing in a foreign currency.

What is the significance of foreign exchange rate risks for manufacturing companies?

For manufacturing companies, foreign exchange rate risks are significant because they often need to purchase raw materials from abroad, which exposes them to fluctuations in exchange rates and impacts their cost structures.

Who is the speaker in the video, and what is their area of expertise?

The speaker in the video is Shakti Ram, who specializes in accounting and finance, and encourages viewers to subscribe for more educational content on these topics.