chapter  1
12 Pages

Currency Risk

Currency risk arises from the potential consequences of an adverse movement in foreign exchange rates. There are three types of exposure to currency risk: transaction, translation and economic.

A transaction exposure starts with a commitment (or intention) to receive income in foreign currency or to make a foreign currency payment at some future point. Foreign currency income would be converted into another currency, typically, domestic currency. Foreign currency payments would be paid for by purchasing the amount of currency required, typically, in exchange for domestic currency. The risk from the exposure is that cash income in the domestic currency will turn out lower than expected, or that cash payments in the domestic currency will turn out higher than expected.