Explain the different kinds of risks in foreign exchange faced by multinational corporations.
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.