¶ … currency risk to which the PPP Group was exposed. The paper also considers their options for currency risk management, in particular evaluating how PPP Group can manage their translation exposure risk.
Types of Currency Risk
The PPP Group's international transactions subject the firm to currency risk or exchange rate risk which arises with the potential change in the exchange rate of EUR against USD. The PPP Group is exposed to three kinds of currency risk that must be managed: transaction risk, translational rick and economic risk. Transaction risk is associated with the time delay that occurs between PPP Group's entering into contracts to purchase paper supplies and the actual contract settlement. PPP Group is also exposed to translation risk which the is the risk of adverse effects on their financial statements, possibly affecting the company's assets, liabilities, equities or income, due to changes in currency exchange rates. PPP Group is exposed to economic risk, which is the danger that the company may be at a disadvantage and unable to sell the paper bags at a profit if exchange rates move against the company.
Pros and Cons of the Hedging Proposal
The local Chief Executive's proposal to hedge 80% of paper purchases one year in advance is one means of hedging against currency risk. Without hedging, a significant amount of the company's accounts payable remains an unmanaged risk. There are academic studies of currency risk that suggest investors who bear currency risk are not compensated with higher returns, which in effect means that it is essentially needless to bear currency risk. The Chief Executive is well advised to develop some kind of hedging strategy to manage their exposure.
The benefit to PPP Group, or pros, of currency hedging is that it potentially reduces their losses. Hedging protects the...
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