Exchange Rates Essay Example | Topics and Well Written Essays - 2000 words

Exchange Rates - Essay Example For instance, let’s say goods are sold by a vendor in United Kingdom to a customer in United States on the first of January, and the customer has promised to make a payment in the next three months. In this case, the risk in question is that the price of dollar to the pound may change over the time period. This change may be on either side, resulting in an exchange gain to one party and loss to the other. Transaction risk often occurs in cases of sales/purchase of goods on credit with payment to be made at a later date, upon receipt of dividend from foreign investments and from borrowing and/or investing in foreign currencies. Transaction risk can be protected against by the use of various hedging instrument (DAVID WINSTONE, 1995). The other kind of risk that we discussed above is translation risk. It occurs when a company has various subsidiaries abroad and needs to consolidate its financial position for reporting purposes. It is pretty much possible that the various currencies in question (that of the subsidiary’s country and the home country) might not be performing well in relation to the host county’s currency and therefore show a very deteriorating position on the consolidated financial statements (PRACHI DEUSKAR, 2007). The best way to counter the impact of translation risk is to get involved in balance sheet hedging. The best way of doing so is making the foreign assets and liabilities equal so as to cut down the impact of any change that might occur in the exchange rates. The third and final case of currency risk mentioned above is economic risk. This risk overall affects the value of the firm in question. It refers to how the change in exchange rates affects the competitiveness of a business on an international scale. To make it simpler to understand, it’s not only the appreciation -or depreciation of a foreign currency to the home currency that affects a company’s operations, but also how a