CURRENCY RISK || TRAIN ANIL MAURYA

Currency Risk Management || Trainer Anil Maurya 
 Objective of the E- book 

To learn how to manage currency risk 
Key Learnings from the Video

1. What is Currency Risk?

Currency risk is also called "exchange rate risk" that arises from the change in the price of one country's currency with respect to another.

Investors or companies that have assets or business operations in other countries are exposed to currency risk.

For example: 

An Indian company agrees to purchase $10,000 worth products every month from a US company. 
In this case, the Indian company has to convert INR into USD for making monthly payment to the US company.
If the price of USD increases, the Indian company has to pay extra for the $10,000, then what they were paying earlier. 
This situation is called currency risk for the Indian company. 
2. Types of Currency Risk 

i. Transaction Risk 

This risk arises when a company deals with another company in a country that has a stronger currency. 
For example, if an Indian company deals with a US company, then the Indian company will always have a transaction risk as the USD is stronger than INR. 
Transaction risk generally takes place when there is a gap between agreement and transaction or there is a continuous agreement of payment. 
2. Translation Risk 

To understand translation risk, you need to know the following terms:

i. Parent/subsidiary Company 

If company A buys/owns more than 50% shareholding of company B, then A becomes "parent/holding company" for B and B becomes "subsidiary company" for A.

ii. Consolidated Profit 

In accounting, a parent company has to merge the profits and losses of its subsidiary company into its profit and losses. This is called consolidated profit (financial statement). 

What is translation risk?

Translation risk arises when a company's parent or subsidiary company is located abroad.
In this case, a parent company has to convert the financials of its subsidiary company into its currency while making consolidated financial statements.
Translation risk is based on translating assets on the balance sheet in foreign currency to domestic currency.
Therefore, fluctuations in the foreign currency (where the subsidiary company is located) can affect the profit of the parent company.
iii. Economic Risk 

Economic risk arises when a company's market value and its cash flow get adversely impacted due to unavoidable currency fluctuations and changes in economic conditions.
This risk takes place due to political instability, change in government regulations, and exchange rates. 
For example, Indian Government's increase and changes in the tax rates had adversely affected Vodafone in 2009.
3. How to Deal With Currency Risk?

Following are the ways to deal with currency risk:

i. Forward Contract 

A forward contract is an agreement that can be done with the bank to fix exchange rates for the near future. 
A company can take forward contracts to avoid future exchange rate fluctuations.
A company chooses a forward contract when it has to make or receive any payment in foreign currency.
With a forward contract, the company can eliminate risk due to fluctuations in exchange rates.
 ii. Currency Options 

Currency option (also known as a forex option) is a contract that gives a company the right, but not the obligation, to cancel or fulfil any deal at a specified exchange rate on or before a specified date.
This means a company has the option to decide to fulfil or cancel any agreement with any company in case of currency fluctuations. 
The company can take currency options from any bank in exchange for a premium. 
Key Outcomes of the Video 

Do forward contract with any bank to avoid the risk due to foreign exchange fluctuations
Opt for currency options to cancel any agreement in the case of foreign exchange fluctuations

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