F3 - 11. Risk Management & Currency Risk Flashcards
What is financial risk?
Risk of future financial conditions being different to those expected
What are the 4 main categories of financial risk?
- Currency risk
- Interest rate risk
- Credit risk
- Political risk
What 4 actions could a government take that would lead to political risk?
- Impose quotas (limits) between parents and subsidiaries
- Impose import/export tariffs
- Nationalisation
- Non-tariff barriers e.g. extra quality or safety checks
What are the 3 measures for managing political risk?
- Negotiations
- Production location strategies
- Use of JV with domestic companies
What are the 3 categories of currency risk?
- Transaction risk
- Economic risk (longer term)
- Translation risk
What is the balance of payments?
The difference between a country’s overseas earning and spending
If a country imports more than it exports, what will happen to the currency strength?
Weaken
What is purchasing power parity theory?
FX rates between two countries are influenced by their respective inflation rates - the country with lower inflation will have its currency strengthen
What is interest rate parity theory?
A fair forward exchange rate between two countries can be determined by the spot exchange rate and respective interest rates - the country with lower interest will have its currency strengthen
What is the international fisher effect?
The only reason that nominal interest rates in two different countries are different is due to differing inflation
What are 5 factors that will influence currency fluctuations?
- Relative inflation levels
- Relative interest rates
- Political stability
- Debt ratings
- Government policies
What are the 4 main internal hedging techniques?
- Invoicing in domestic currency
- Matching receipts and payments in a foreign account
- Leading and lagging (chasing exchange rate)
- Multilateral netting (intra-group netting centre)
What is a forward exchange contract?
A binding agreement to buy or sell an amount of a currency in the future at a set price on a set date
What are FX forwards used for?
To eliminate transaction risk
How do you treat the discount/premium on a forward spot price?
Add a discount, deduct a premium
