International Finance Coursework Essay Example | Topics and Well Written Essays - 1500 words

International Finance Coursework - Essay Example A firm therefore needs to keep the exchange rate risk at bay. Most firms do so by determining the specific type of exposure to risk, the hedging approach and they also find available instruments to deal with these currency risks. The international transactions the British Venture Capitalist is involved in, exposes them to exchange rate risk. They therefore have to plan in advance and take measures that will protect them against these risks to avoid incurring great losses. There are different types of risks or currency exposures the British Capitalist faces: Transaction risk or simply known as the cash ?ow risk deals with the effect of exchange rate changes position on transactional account exposure linked to receivable, or repatriation of dividends and payables. Any change in the currency exchange rate results in a transaction risk. Translation risk also known as balance sheet exchange rate risk shows the relationship of exchange rate change position to the valuation of a foreign sub ordinate firm and, in turn, to the consolidation of a foreign subordinate firm to the mother corporation’s balance sheet. ... There is a difference however in translation when it comes to the income statements. In the income statement translations are done at the usual exchange rate during the time period. In the case of balance sheets, translations are done at the predominant present exchange rate at the time of consolidation. Economic risk is the risk which reflects the risk to the firm’s value of future operating cash ?ows from exchange rate movements. It is concerned with the effect of exchange rate changes on revenues and operating expenses. The revenues in this case include domestic sales and exports whereas operating expenses include the domestic inputs and imports. This type of risk is normally applied to the current worth of future cash flow operations of a firm. Question (b) How to Measure Economic/Operating Exposure After de?ning the types of economic/operating exposure that a ?rm is exposed to, a crucial aspect of a ?rm’s exchange rate risk management decisions is the measurement o f economic/operating exposure. Measuring economic/operating exposure may seem to be challenging. Currently, the most commonly applied methodology is the value-at-risk (VaR) model. Generally, value at risk is de?ned as the highest loss for a given exposure over a given period of time with a certain percentage of con?dence. The VaR method can be useful in computing a range of types of risk, helping corporations in their risk management. Nevertheless, the VaR does not suggest what happens to the exposure for the (100 – z) % point of con?dence, i.e., the worst case scenario. The Value-at-Risk (VaR) calculation method of economic/operating exposure is applied by corporations to estimate the riskiness of a foreign exchange situation that culminates from a