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Exchange rate risk

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Definition of Exchange rate risk

Exchange Rate Risk Image 1

Exchange rate risk

Also called currency risk, the risk of an investment's value changing because of currency
exchange rates.



Related Terms:

Currency risk

Related: exchange rate risk


discount rate

the rate of return on investment that would be required by a prudent investor to invest in an asset with a specific level risk. Also, a rate of return used to convert a monetary sum, payable or receivable in the future, into present value.


Accelerated cost recovery system (ACRS)

Schedule of depreciation rates allowed for tax purposes.


Accelerated depreciation

Any depreciation method that produces larger deductions for depreciation in the
early years of a project's life. Accelerated cost recovery system (ACRS), which is a depreciation schedule
allowed for tax purposes, is one such example.


Active portfolio strategy

A strategy that uses available information and forecasting techniques to seek a
better performance than a portfolio that is simply diversified broadly. Related: passive portfolio strategy



Adjustable rate preferred stock (ARPS)

Publicly traded issues that may be collateralized by mortgages and MBSs.


After-tax real rate of return

Money after-tax rate of return minus the inflation rate.


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All equity rate

The discount rate that reflects only the business risks of a project and abstracts from the
effects of financing.


American Stock Exchange (AMEX)

The second-largest stock exchange in the United States. It trades
mostly in small-to medium-sized companies.


Amortizing interest rate swap

Swap in which the principal or national amount rises (falls) as interest rates
rise (decline).


Annual percentage rate (APR)

The periodic rate times the number of periods in a year. For example, a 5%
quarterly return has an APR of 20%.


Arithmetic average (mean) rate of return

Arithmetic mean return.


Auction rate preferred stock (ARPS)

Floating rate preferred stock, the dividend on which is adjusted every
seven weeks through a Dutch auction.


Average rate of return (ARR)

The ratio of the average cash inflow to the amount invested.


Average tax rate

Taxes as a fraction of income; total taxes divided by total taxable income.


Bankruptcy risk

The risk that a firm will be unable to meet its debt obligations. Also referred to as default or insolvency risk.


Exchange Rate Risk Image 3

Barbell strategy

A strategy in which the maturities of the securities included in the portfolio are concentrated
at two extremes.


Base interest rate

Related: Benchmark interest rate.



Basic business strategies

Key strategies a firm intends to pursue in carrying out its business plan.


Basis risk

The uncertainty about the basis at the time a hedge may be lifted. Hedging substitutes basis risk for
price risk.


Benchmark interest rate

Also called the base interest rate, it is the minimum interest rate investors will
demand for investing in a non-Treasury security. It is also tied to the yield to maturity offered on a
comparable-maturity Treasury security that was most recently issued ("on-the-run").


Bill of exchange

General term for a document demanding payment.


Break-even payment rate

The prepayment rate of a MBS coupon that will produce the same CFY as that of
a predetermined benchmark MBS coupon. Used to identify for coupons higher than the benchmark coupon
the prepayment rate that will produce the same CFY as that of the benchmark coupon; and for coupons lower
than the benchmark coupon the lowest prepayment rate that will do so.


Break-even tax rate

The tax rate at which a party to a prospective transaction is indifferent between entering
into and not entering into the transaction.


Broker loan rate

Related: Call money rate.


Bullet strategy

A strategy in which a portfolio is constructed so that the maturities of its securities are highly
concentrated at one point on the yield curve.


Business risk

The risk that the cash flow of an issuer will be impaired because of adverse economic
conditions, making it difficult for the issuer to meet its operating expenses.


Buy-and-hold strategy

A passive investment strategy with no active buying and selling of stocks from the
time the portfolio is created until the end of the investment horizon.



Call money rate

Also called the broker loan rate , the interest rate that banks charge brokers to finance
margin loans to investors. The broker charges the investor the call money rate plus a service charge.


Call risk

The combination of cash flow uncertainty and reinvestment risk introduced by a call provision.


Chicago Mercantile Exchange (CME)

A not-for-profit corporation owned by its members. Its primary
functions are to provide a location for trading futures and options, collect and disseminate market information,
maintain a clearing mechanism and enforce trading rules.


Combination strategy

A strategy in which a put and with the same strike price and expiration are either both
bought or both sold. Related: Straddle


Commercial risk

The risk that a foreign debtor will be unable to pay its debts because of business events,
such as bankruptcy.


Commodities Exchange Center (CEC)

The location of five New York futures exchanges: Commodity
exchange, Inc. (COMEX), the New York Mercantile exchange (NYMEX), the New York Cotton exchange,
the Coffee, Sugar and Cocoa exchange (CSC), and the New York futures exchange (NYFE). common size
statement A statement in which all items are expressed as a percentage of a base figure, useful for purposes of
analyzing trends and the changing relationship between financial statement items. For example, all items in
each year's income statement could be presented as a percentage of net sales.


Company-specific risk

Related: Unsystematic risk


Completion risk

The risk that a project will not be brought into operation successfully.


Conglomerate

A firm engaged in two or more unrelated businesses.


Conglomerate merger

A merger involving two or more firms that are in unrelated businesses.


Convertible exchangeable preferred stock

Convertible preferred stock that may be exchanged, at the
issuer's option, into convertible bonds that have the same conversion features as the convertible preferred
stock.


Corporate acquisition

The acquisition of one firm by anther firm.


Corporate bonds

Debt obligations issued by corporations.


Corporate charter

A legal document creating a corporation.


Corporate finance

One of the three areas of the discipline of finance. It deals with the operation of the firm
(both the investment decision and the financing decision) from that firm's point of view.


Corporate financial management

The application of financial principals within a corporation to create and
maintain value through decision making and proper resource management.


Corporate financial planning

Financial planning conducted by a firm that encompasses preparation of both
long- and short-term financial plans.


Corporate processing float

The time that elapses between receipt of payment from a customer and the
depositing of the customer's check in the firm's bank account; the time required to process customer
payments.


Corporate tax view

The argument that double (corporate and individual) taxation of equity returns makes
debt a cheaper financing method.


Corporate taxable equivalent

rate of return required on a par bond to produce the same after-tax yield to
maturity that the premium or discount bond quoted would.


Counterparty risk

The risk that the other party to an agreement will default. In an options contract, the risk
to the option buyer that the option writer will not buy or sell the underlying as agreed.
Country economic risk Developments in a national economy that can affect the outcome of an international
financial transaction.


Country financial risk

The ability of the national economy to generate enough foreign exchange to meet
payments of interest and principal on its foreign debt.


Country risk General

Level of political and economic uncertainty in a country affecting the value of loans or
investments in that country.


Coupon rate

In bonds, notes or other fixed income securities, the stated percentage rate of interest, usually
paid twice a year.


Covered call writing strategy

A strategy that involves writing a call option on securities that the investor
owns in his or her portfolio. See covered or hedge option strategies.


Covered or hedge option strategies

Strategies that involve a position in an option as well as a position in the
underlying stock, designed so that one position will help offset any unfavorable price movement in the other,
including covered call writing and protective put buying. Related: naked strategies


Credit risk

The risk that an issuer of debt securities or a borrower may default on his obligations, or that the
payment may not be made on a negotiable instrument. Related: Default risk


Crediting rate

The interest rate offered on an investment type insurance policy.


Cross rates

The exchange rate between two currencies expressed as the ratio of two foreign exchange rates
that are both expressed in terms of a third currency.


Cross-border risk

Refers to the volatility of returns on international investments caused by events associated
with a particular country as opposed to events associated solely with a particular economic or financial agent.


Crossover rate

The return at which two alternative projects have the same net present value.


Currency risk sharing

An agreement by the parties to a transaction to share the currency risk associated with
the transaction. The arrangement involves a customized hedge contract embedded in the underlying
transaction.


Current rate method

Under this currency translation method, all foreign currency balance-sheet and income
statement items are translated at the current exchange rate.


Dedication strategy

Refers to multi-period cash flow matching.


Default risk

Also referred to as credit risk (as gauged by commercial rating companies), the risk that an
issuer of a bond may be unable to make timely principal and interest payments.


Discount rate

The interest rate that the Federal Reserve charges a bank to borrow funds when a bank is
temporarily short of funds. Collateral is necessary to borrow, and such borrowing is quite limited because the
Fed views it as a privilege to be used to meet short-term liquidity needs, and not a device to increase earnings.


Diversifiable risk

Related: unsystematic risk.


Dividend rate

The fixed or floating rate paid on preferred stock based on par value.


Dollar-weighted rate of return

Also called the internal rate of return, the interest rate that will make the
present value of the cash flows from all the subperiods in the evaluation period plus the terminal market value
of the portfolio equal to the initial market value of the portfolio.


Economic risk

In project financing, the risk that the project's output will not be salable at a price that will
cover the project's operating and maintenance costs and its debt service requirements.


Effective annual interest rate

An annual measure of the time value of money that fully reflects the effects of
compounding.


Effective rate

A measure of the time value of money that fully reflects the effects of compounding.


Equilibrium market price of risk

The slope of the capital market line (CML). Since the CML represents the
return offered to compensate for a perceived level of risk, each point on the line is a balanced market
condition, or equilibrium. The slope of the line determines the additional return needed to compensate for a
unit change in risk.


Equilibrium rate of interest

The interest rate that clears the market. Also called the market-clearing interest
rate.


Event risk

The risk that the ability of an issuer to make interest and principal payments will change because
of rare, discontinuous, and very large, unanticipated changes in the market environment such as (1) a natural
or industrial accident or some regulatory change or (2) a takeover or corporate restructuring.


Exchange

The marketplace in which shares, options and futures on stocks, bonds, commodities and indices
are traded. Principal US stock exchanges are: New York Stock exchange (NYSE), American Stock exchange
(AMEX) and the National Association of Securities Dealers (NASDAQ)


The Exchange

A nickname for the New York stock exchange. Also known as the Big Board. More than
2,000 common and preferred stocks are traded. The exchange is the oldest in the United States, founded in
1792, and the largest. It is located on Wall Street in New York City.


Exchange controls

Governmental restrictions on the purchase of foreign currencies by domestic citizens or
on the purchase of the local domestic currency by foreigners.


Exchange of assets

Acquisition of another company by purchase of its assets in exchange for cash or stock.


Exchange of stock

Acquisition of another company by purchase of its stock in exchange for cash or shares.


Exchange offer

An offer by the firm to give one security, such as a bond or preferred stock, in exchange for
another security, such as shares of common stock.


Exchange rate

The price of one country's currency expressed in another country's currency.


Exchange Rate Mechanism (ERM)

The methodology by which members of the EMS maintain their
currency exchange rates within an agreed upon range with respect to other member countries.


Exchange risk

The variability of a firm's value that results from unexpected exchange rate changes or the
extent to which the present value of a firm is expected to change as a result of a given currency's appreciation
or depreciation.


Exchangeable Security

Security that grants the security holder the right to exchange the security for the
common stock of a firm other than the issuer of the security.


Fallout risk

A type of mortgage pipeline risk that is generally created when the terms of the loan to be
originated are set at the same time as the sale terms are set. The risk is that either of the two parties, borrower
or investor, fails to close and the loan "falls out" of the pipeline.


Federal funds rate

This is the interest rate that banks with excess reserves at a Federal Reserve district bank
charge other banks that need overnight loans. The Fed Funds rate, as it is called, often points to the direction
of U.S. interest rates.


Financial risk

The risk that the cash flow of an issuer will not be adequate to meet its financial obligations.
Also referred to as the additional risk that a firm's stockholder bears when the firm utilizes debt and equity.


Firm-specific risk

See:diversifiable risk or unsystematic risk.


Fixed-exchange rate

A country's decision to tie the value of its currency to another country's currency, gold
(or another commodity), or a basket of currencies.


Fixed-rate loan

A loan on which the rate paid by the borrower is fixed for the life of the loan.


Fixed-rate payer

In an interest rate swap the counterparty who pays a fixed rate, usually in exchange for a
floating-rate payment.


Flat price risk

Taking a position either long or short that does not involve spreading.


Floating exchange rate

A country's decision to allow its currency value to freely change. The currency is not
constrained by central bank intervention and does not have to maintain its relationship with another currency
in a narrow band. The currency value is determined by trading in the foreign exchange market.


Floating-rate contract

A guaranteed investment contract where the credit rating is tied to some variable
("floating") interest rate benchmark, such as a specific-maturity Treasury yield.


Floating-rate note (FRN)

Note whose interest payment varies with short-term interest rates.


Floating-rate payer

In an interest rate swap, the counterparty who pays a rate based on a reference rate,
usually in exchange for a fixed-rate payment


Floating-rate preferred

Preferred stock paying dividends that vary with short-term interest rates.


Force majeure risk

The risk that there will be an interruption of operations for a prolonged period after a
project finance project has been completed due to fire, flood, storm, or some other factor beyond the control
of the project's sponsors.


Foreign exchange

Currency from another country.


Foreign exchange controls

Various forms of controls imposed by a government on the purchase/sale of
foreign currencies by residents or on the purchase/sale of local currency by nonresidents.



 

 

 

 

 

 

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