6. Foreign exchange risk Companies that compete in the global economy face vario

Question

6. Foreign exchange risk Companies that compete in the global economy face various types of risks-for example, foreign exchange risk. Three distinct categories of foreign exchange risk are transaction risk, economic risk, and translation risk. Consider the following case: Rihana works for a multinational conglomerate firm. The firm's business extends across different sectors, such as computers, consumer electronics, and automobiles. Her job is to monitor foreign exchange risk and recommend strategies for managing it. Situation The firm sold $2 million worth of heavy machinery to an Egyptian company. The U.S. firm entered into a two-year contract just before the Egyptian political crisis in early 2011. The political conditions and volatile Egyptian stock markets were expected to impact the Egyptian pound. Rihana identifies the risk, classifies it, and recommends potential strategies. Based on your understanding of foreign exchange risk, complete the tasks involved in Rihana's analysis. Identify the risk Type of risk Strategies for managing the risk Operating exposure Transaction exposure Short-term risk O Long-term risk O Start production in Egypt. O Invest in interest-bearing Egyptian securities. O Reduce manufacturing costs for the contract O Translation exposure

Explanation / Answer

The risk here is transaction risk, as it is mentioned that Egyptian pound is expected to impacted due to political conditions and this arouse due to a transaction already committed.

Hence, risk identified is Transaction risk.

The contract is to be executed after 2 years, hence the risk is a Long term risk.

Strategies for managing the risk is to invest in interest bearing Egyptian securities.

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