Sunday, March 15, 2009

currency risk

also Known as exchange risk,currency risk arises when an obligation has to be settled in acurrency other than your 'domestic' currency . Exchange rates move all the time and the mount of domestic currency that can be expected to be received for agiven amount of foreign currency will moves as aconsequence.
movements can be favourable , resulting in windfall gains they can equally easily be unfavourable .businesses that operate on tight profit margins can ill afford to have their expected income reduced ,or their costs increased , through unfavourable exchange rate movements . such businesses should either invoice in domestic currency when selling aboard ,or insist in paying in domestic currency for imports-in other words ,pass on the exchange risk to the buyer of goods when selling and/or to the seller of goods when buying .if this is not possible ,fixing the domestic currency amount to be received or paid through ahedging mechanism,such as aforward exchange contract,is advisable.
lenders are sometimes asked to lend in foreign currency .this is usually the case when there is tract record of interest rates for that currency being generally lower than for domestic currency borrowing.whilst this can be superficially attractive ,it can be highly dangerous with the borrower being exposed to adverse exchange rate movements.currency borrowing only usually makes sense where the borrower has areasonably certain cash inflow in that currency from , say , export sales , to meet the loan repayment and interest servicing requirements

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