The risk of foreign Exchange Exposure 1. Introduction 2. Exchange Risk with “One Currency” 3. Exchange Risk with “Multiple Currencies” 4. Conclusion

1. Introduction -Before: We have already talked about the different kinds of Foreign Exchange Exposure: -Translations Exposure (Accounting) -Transaction Exposure (Accounting) - Economic Exposure (Economic) -Now: We will analyze the RISK associated to this exposure.

2. Exchange Risk with one currency Three types of exposure: –Exchange rate is fixed  No variability   = 0 (No Risk) –Exchange rate is variable  Low variability   0 (Low Risk)  High Variability   0 (High Risk)

2. Exchange Risk with one currency z $1.1/£ $1.4/£ $1.7/£ $2/£ $2.3/£ $2.6/£ $2.9/£ Suppose: - - Future Exchange rate is $2/£  = 15 % 68% 95%

2. Exchange Risk with one currency z $1.1m $1.4m $1.7m $2m $2.3m $2.6m $2.9m Suppose: £1’000,000 Receivable (£1m) 68% 95%

2. Exchange Risk with one currency What to do as managers:  Analyze the volatility of the exchange rate 

3. Exchange Risk with multiple currencies -Is more complex -It is necessary to analyze the correlation among currencies.

3. Exchange Risk with multiple currencies

Risk = Sum of exchange Variances + Sum of Covariance of particular currencies Example: Variance of annual percentage changes in Yen/$ is 600 percentage points, and Variance of DM/$ is 550 percentage points. From Table 8-2, correlation is thus the covariance is What is the exchange risk associated with $100 of Yen and $100 of DM? Risk = Sum of exchange Variances + Sum of Covariance of particular currencies

3. Exchange Risk with multiple currencies 100^2Var(Ry) + 100^2Var(Rdm) + 2(100^2)Cov(Ry,Rdm) Var = 100^2( (346.5)) = 100^2*1793 SD = Square Root of 100^2*1793 = 4234 cents or $42.34

4. Conclusion As managers we have to take into account the risk of our exposure in different currencies.