There are three types of risks associated with foreign exchange –
● Transaction risk − This is the risk of an exchange rate change on transaction date and the subsequent settlement date, i.e., it is the gain or loss arising on conversion.
● Economic risk − Transactions depend on relatively short-term cash flow effects. However, economic exposure encompasses the longer-term effects on the market value of a company. Simply put, it is a change in the present value of the future after-tax cash-flows for exchange rate changes.
● Translation risk − The financial statements are usually translated into the home currency to consolidate into the group’s financial statements. It can pose a challenge when exchange rates change.