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Any business unit faces foreign exchange risk in three waystransaction risk, translation risk and economic risk. Contrary to the common notion, economic exposure has a significant impact not just on companies with foreign exchange exposures but on all companies in general. With the ripple effect of economic changes in one part of the world being widely felt in another part, economic risk has become a focus of discussion in today's globalized world. It is highly essential that risk managers take-up adequate steps to identify and insulate against economic risks if the companies' operations are not to be adversely affected. What role does economic exposure actually play in forex risk? Learn the answer.
Charles Tschampion, Managing Director of the $ 50 bn General Motors pension fund, once remarked that the real challenge for any company is not to take more risk than needed to generate the return that is offered. It is an iconic statementpregnant with a high degree of philosophical and mathematical sophistication. But the question is how to know beforehand, how much risk one is taking. Secondly, if one has to manage risk, one should also know what items and amounts of a firm are exposed to risk. This problem gets compounded if one's business is exposed to foreign exchange rate risk that too, when markets are witnessing frequent bouts of excessive volatility. Indeed it is not uncommon among the business men to exasperate about their helplessness in the fight to control the associated risks that arise when exporting or importing goods and services, etc.
In a financial context, `risk' refers to the probability of loss. In basic arithmetic terms, a company makes loss whenever its income is less than the expenditure incurred for generating that income. So long, as one records income and expenses in rupee terms, working out profit or loss is no big a task. But if a business is having receipts and payments in two different currencies, profit or loss calculation gets complicated. One way of overcoming this problem is to convert foreign currency receipts into rupees so that revenues can be compared with the rupee cost of production and profit/loss can be arrived at. The other alternative is to convert the rupee cost into foreign currency, compare it with the receipts in foreign currency, and workout the profit. In either of the cases the exchange rate of rupee against the foreign currency at which such conversions are done, becomes a key variable in determining the profit or loss.
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