Currency risk is the probability of financial losses resulting from currency changes that may occur between the conclusion of the contract and the actual settlement of the contract.
The exchange rate, based on the purchasing power of currencies, is very fluid.
Among the main factors affecting the exchange rate, it is necessary to highlight the state of the balance of payments, inflation rate, intersectoral migration of short-term capital. In general, exchange rate movements are influenced by the supply-demand ratio of each currency.
In addition to economic factors, the exchange rate is influenced by political factors.
In turn, the exchange rate has a serious impact on the foreign economic activity of the country, which is one of the prerequisites for equivalence of international exchange. Its level has a significant impact on a country 's export competitiveness in world markets.
The low exchange rate provides additional export benefits and facilitates foreign capital inflows while discouraging imports.
The opposite economic situation arises when the currency is overvalued (export efficiency decreases and import efficiency increases).
Significant unforeseen fluctuations, exchange rate divergence from purchasing power ratios increase monetary and financial tensions, disrupt normal international exchange.
Currency risk includes three varieties:
- economic risk;
- transfer risk;
- risk of transactions.
The economic risk to a business firm is that the value of its assets and liabilities may change higher or lower (in national currency) due to future exchange rate changes.
This also applies to investors whose foreign investments - shares or debt - generate income in foreign currency.
The transfer risk is of an accounting nature and relates to differences in the accounting of the firm 's assets and liabilities in foreign currency.
If the exchange rate of the foreign currency in which the firm 's assets are expressed falls, the value of these assets decreases.
It should be borne in mind that the risk of transfer is an accounting effect, but does not reflect the economic risk of the transaction at all.
More economically important is the risk of the transaction, which considers the impact of the exchange rate change on the future flow of payments, and therefore on the future profitability of the enterprise firm as a whole.
Transaction risk is the probability of cash foreign exchange losses for specific foreign currency transactions.
The risk of transactions arises from the uncertainty of the value in the national currency of the foreign exchange transaction in the future.
This type of risk exists both when entering into trade contracts and when obtaining or granting loans and consists in the possibility of changing the amount of receipt or payments when converting in local currency.