The danger arises when a corporation conducts financial transactions or keeps financial records in a currency other than the one on which it is based. A Canadian company doing business in China, for example, is subject to foreign exchange risk because it accepts financial transactions in the Chinese Yuan and presents its financial results in Canadian dollars.
There are a variety of different types of foreign exchange risks.
- The danger of a transaction - Transaction risk is the risk that a company bears while doing international financial transactions. The currency rate may change before the transaction is finalized, posing a risk. In essence, the time between transaction and settlement is the source of transaction risk. Transaction risk can be reduced by using forward contracts and swaps.
- Economic danger - Economic risk, often known as forecast risk, is the risk that an organization's market value will be impacted by inevitable exchange rate movements. This type of risk is typically produced by macroeconomic variables such as geopolitical instability and/or government laws.
- The dangers of translation - The risk posed by a corporation with a domestic headquarters but conducting business in a foreign jurisdiction, whose financial performance is signified in its native currency, is known as translation risk of translation exposure. The risk of translation increases when a company holds a bigger percentage of its assets, liabilities, or stock in a foreign currency.
