Explain the different kinds of risk in foreign exchange faced by multinational corporation
Answers
The types of exchange rate risks multinational companies’ face are:
Transaction risk: Multinational companies that sell products to overseas customer are subjected to transaction risk. Suppose a UK company sold a product worth £1,000,000 to US customer and expecting a payment in June, but, the invoice was made in January. By the time the exchange rate has changed. Say US$1.40 in January and US$1.50 in June, then the UK Company would lose £47,619.
Economic risk: Multinational companies when dealing globally are subjected to economic risk. Any changes in the exchange rate affect the relative prices on imports and exports which in turn affect the competitiveness of a company.
Translation risk or Hidden risk: Multinational companies having subsidiaries in other countries are subjected to translation risk. On the financial statement of the whole group, the company may have to translate the assets and liabilities from foreign accounts into the group statement. The term hidden risk revolves around the fact that all companies are subject to exchange rate risks, even if they don’t do business with companies using other currencies.