Exchange Risk
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Transcript of Exchange Risk
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BY- MONIKA SOOD
JITENDRA SINGH
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INTRODUCTION
Foreign exchange risk is the
possibility of a gain or loss to a
firm that occurs due tounanticipated changes in
exchange rate.
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EXCHANGE RISK IS
DIVERSIFIABLE.
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TYPES
TYPES OF EXPOSURE
TRANSLATIONTRANSACTIO
NECONOMIC
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TRANSLATION EXPOSURE
It is the degree to which a firm`s
currency denominated financial
statements are affected by exchangerate changes.
It is also called accounting exposure.
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TYPES
Current rate method
Current/non-current method
Monetary/non-monetary method
Temporal method
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Current rate method
All items of balance sheet and
income statement are translated
at current rate or post changerate.
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Merit of this method is that the relative
proportion of individual balance sheet
accounts remains the same and the process
does not distort various balance sheet ratios.
Demerit is that the fixed assets are also
translated at current rate that goes against the
principles of accounting.
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Current/ non current method
Only current assets and current liabilities
are translated at current rate or post
change rate but the fixed assets and longterm liabilities are translated at historical
rate.
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Demerit of this method is that the
long term debts which is also
exposed to exchange rate change isignored by this method.
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Monetary/ non-monetary method
Items that represent a claim to receive come
under monetary group whereas physical
assets and liabilities come under non-
monetary group.
Monetary assets and liabilities are translated
at current rate while non-monetary assets and
liabilities are translated at historical rate.
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Temporal method
Historical cost items are translated at historical
rate while items that are related to replacement
cost ,market value are translated at current rate.
This method resembles the monetary/non-monetary method only the difference is that in
temporal method inventory is translated at
current rate if it is shown at market value but informer the inventory is always translated at
historical rates.
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ECONOMIC EXPOSURE
It refers to the degree to which a firm`s
present value future cash flows can be
influenced by exchange rate fluctuations. Hence, this exposure affects the
profitability of the company over a longer
time span than translation or transactionexposure.
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Economic exposure cannot be
hedged while both transaction and
translation exposure can be hedged.
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TRANSACTION EXPOSURE
It refers to the extent to which the
future value of firm`s domestic cash
flow is affected by exchange ratefluctuations.
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