DERIVATIVES AND RISK

Derivatives and Risk



Derivatives and Risk

Introduction

When a company wants to expand the operations to other countries, many factors are to be considered. Foreign currency exchange, foreign currency translation, hedging are the main factors. These are directly related, when the transactions are made in different currencies depending on the host and home countries. The exchange rate risk is captured by movements in the exchange rate in the opposite direction of this scheme fluctuations between the exchange rates changes in the value of one currency in terms of another are variations in the exchange rate affecting the total wealth of the traders who hold positions in foreign currency. The risk can define as the ability to incur losses because of the direct effects of exchange rate changes on expected cash flows. Exporter receives foreign currency for the goods sold, will lose from the depreciation of foreign currencies in relation to national, then as an importer, make payment in foreign currency, will lose from the appreciation of foreign currencies relative to the national.

Exchange Rates

Exchange rate is the price of the currency of one country, expressed in monetary units of other countries and sales transactions (Madura, 2009, p. 50). This price can be set based on supply and demand in a certain currency in a free market, or to be strictly regulated the government's decision or its main financial body, usually the central bank.

Currency Translation

In accounting and financial terms, the foreign currency translation is normally used to convert and measure a foreign subsidiary's financial performance in other foreign currency. The basic use of currency translation is destined to report the financial statement of the company in another foreign currency with an equivalent value. In the absence of foreign currency translation, the consolidation of financial statements among the multinational companies would be very difficult or impossible in few cases. Currency translation may treat distinct financial statements in different ways with respect to the exchange rates (historical or current).

The positions of the income statement are translated either at the current rate at the time expenses, or income has been made, or a weighted average exchange rate appropriate. The gain or loss of consolidation is not included in the calculation of net income. They are reported in an account of equity (equity Adjustment from translation). Only when the parent company makes the sale or liquidation of the investment in foreign subsidiary earnings or accumulated losses from previous years are part of the calculation of the profits of the company (Levi, 2005, p. 488).

There are three ways to define the cross-exchange rates: two direct quotes, indirect quotes in two and indirect and direct quotation to the dollar.

The direct exchange of two currencies, such as the euro and the pound, that is USD / EUR and USD / GBP. Then to find the cross of the euro pound GBP / EUR exchange rate is necessary to divide the first currency in the course of the second. This is the method of direct ...