Exchange rate risk
Exchange rate risk, also known as exchange rate risk or exchange risk, refers to the devaluation of economic entities in foreign currencies or The possibility of loss due to changes in currency exchange rates in the local currency value of assets and liabilities, revenues and expenses, and cash flows expected to be generated from future operating activities. The reason why it is called a risk is that this loss is only a possibility, not a certainty.
Types
Can be divided into transaction risk, translation risk (accounting risk), economic risk (operational risk) risk).
Transaction exchange rate risk
In transactions that use foreign currencies for pricing, receipt and payment, the economic entity will be affected by the foreign exchange rate. the possibility of suffering losses due to changes. Transaction risks mainly occur in the following situations:
(1) Risks in import and export transactions of goods and services.
(2) Risks of capital input and output.
(3) Risks of foreign exchange positions held by foreign exchange banks.
Translation risk
Also known as accounting risk, it refers to the accounting treatment of the balance sheet by economic entities. , the possibility of book losses due to exchange rate changes when converting the functional currency into the accounting currency.
Functional currency refers to the various currencies used in circulation among economic entities and business activities.
The reporting currency is the reporting currency used in preparing consolidated financial statements, usually the national currency.
Economic risk
Also known as operating risk, refers to unexpectedForeign exchange rate changes affect the company's production and sales quantity, price, and cost, causing a potential loss that reduces the company's earnings or cash flow in a certain period in the future.
There are mainly four basic factors affecting exchange rate fluctuations:
1. Balance of payments and foreign exchange reserves
The so-called balance of payments is the comparison of a country's total monetary income and the total monetary expenditures paid to other countries. If the total monetary income is greater than the total expenditure, there will be a balance of payments surplus, and vice versa, it will be a balance of payments deficit. The balance of payments situation can have a direct impact on changes in a country's exchange rate. An international balance of payments surplus will cause the country's currency's external exchange rate to rise; conversely, the country's currency exchange rate will fall;
2. Interest rates
Interest rate, as a basic reflection of a country’s borrowing status, plays a decisive role in exchange rate fluctuations. The level of interest rates directly affects international capital flows. Countries with high interest rates experience capital inflows, while countries with low interest rates experience capital outflows. Capital flows will cause changes in the supply and demand relationship in the foreign exchange market, thereby affecting the fluctuations of foreign exchange rates. Generally speaking, an increase in a country's interest rate will lead to an appreciation of the country's currency, and conversely, a depreciation of the country's currency;
3. Inflation
Generally speaking, inflation will cause the domestic currency exchange rate to fall, and the relief of inflation will cause the exchange rate to rise. Inflation affects the value and purchasing power of the local currency, which will lead to a weakening of the competitiveness of imported goods and an increase in exports. It will also have a psychological impact on the foreign exchange market and weaken the credit status of the local currency in the international market. These three impacts will lead to the depreciation of the local currency;
4. Political situation
Changes in the political situation within a country and internationally will have an impact on the foreign exchange market. Changes in the political situation generally include political conflicts, military conflicts, elections and regime changes. These political factors sometimes have a great impact on the exchange rate, but the impact time limit is generally very short.
