Financial Terms
Exchange risk

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Definition of Exchange risk

Exchange Risk Image 1

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.

Related Terms:

Foreign exchange risk

The risk that a long or short position in a foreign currency might have to be closed out
at a loss due to an adverse movement in the currency rates.

Exchange rate risk

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

Covered interest arbitrage

A portfolio manager invests dollars in an instrument denominated in a foreign
currency and hedges his resulting foreign exchange risk by selling the proceeds of the investment forward for

Parallel loan

A process whereby two companies in different countries borrow each other's currency for a
specific period of time, and repay the other's currency at an agreed maturity for the purpose of reducing
foreign exchange risk. Also referred to as back-to-back loans.

American Stock Exchange (AMEX)

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

Bankruptcy risk

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

Basis risk

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

Exchange Risk Image 2

Bill of exchange

General term for a document demanding payment.

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.

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.

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.

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

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.

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

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.

Currency risk

Related: exchange rate risk

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

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.

Diversifiable risk

Related: unsystematic risk.

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.

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.

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.


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.

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.

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.

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.

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.

Foreign exchange dealer

A firm or individual that buys foreign exchange from one party and then sells it to
another party. The dealer makes the difference between the buying and selling prices, or spread.

Foreign exchange swap

An agreement to exchange stipulated amounts of one currency for another currency
at one or more future dates.

Forward exchange rate

exchange rate fixed today for exchanging currency at some future date.

Funding risk

Related: interest rate risk

Geographic risk

risk that arises when an issuer has policies concentrated within certain geographic areas,
such as the risk of damage from a hurricane or an earthquake.

Gold exchange standard

A system of fixing exchange rates adopted in the Bretton Woods agreement. It
involved the U.S. pegging the dollar to gold and other countries pegging their currencies to the dollar.

Herstatt risk

The risk of loss in foreign exchange trading that one party will deliver foreign exchange but the counterparty financial institution will fail to deliver its end of the contract. It is also referred to as settlement risk.

Historical exchange rate

An accounting term that refers to the exchange rate in effect when an asset or
liability was acquired.

Idiosyncratic Risk

Unsystematic risk or risk that is uncorrelated to the overall market risk. In other words,
the risk that is firm specific and can be diversified through holding a portfolio of stocks.

Inflation risk

Also called purchasing-power risk, the risk that changes in the real return the investor will
realize after adjusting for inflation will be negative.

Insolvency risk

The risk that a firm will be unable to satisfy its debts. Also known as bankruptcy risk.

Interest rate risk

The risk that a security's value changes due to a change in interest rates. For example, a
bond's price drops as interest rates rise. For a depository institution, also called funding risk, the risk that
spread income will suffer because of a change in interest rates.

Liquidity risk

The risk that arises from the difficulty of selling an asset. It can be thought of as the difference
between the "true value" of the asset and the likely price, less commissions.

London International Financial Futures Exchange (LIFFE)

A London exchange where Eurodollar futures
as well as futures-style options are traded.

London International Financial Futures Exchange (LIFFE)

London exchange where Eurodollar futures as well as futures-style options are traded.

Market price of risk

A measure of the extra return, or risk premium, that investors demand to bear risk. The
reward-to-risk ratio of the market portfolio.

Market risk

risk that cannot be diversified away. Related: systematic risk

Mortgage-pipeline risk

The risk associated with taking applications from prospective mortgage borrowers
who may opt to decline to accept a quoted mortgage rate within a certain grace period.

New York Stock Exchange (NYSE)

Also known as the Big Board or The Exhange. More than 2,00 common
and preferred stocks are traded. The exchange is the older in the United States, founded in 1792, and the
largest. It is lcoated on Wall Street in New York City

Nominal exchange rate

The actual foreign exchange quotation in contrast to the real exchange rate that has
been adjusted for changes in purchasing power.

Nondiversifiable risk

risk that cannot be eliminated by diversification.

Nonsystematic risk

Nonmarket or firm-specific risk factors that can be eliminated by diversification. Also
called unique risk or diversifiable risk. Systematic risk refers to risk factors common to the entire economy.

Operating risk

The inherent or fundamental risk of a firm, without regard to financial risk. The risk that is
created by operating leverage. Also called business risk.

Organized exchange

A securities marketplace wherein purchasers and sellers regularly gather to trade
securities according to the formal rules adopted by the exchange.

Overnight delivery risk

A risk brought about because differences in time zones between settlement centers
require that payment or delivery on one side of a transaction be made without knowing until the next day
whether the funds have been received in an account on the other side. Particularly apparent where delivery
takes place in Europe for payment in dollars in New York.

Philadelphia Stock Exchange (PHLX)

A securities exchange where American and European foreign
currency options on spot exchange rates are traded.

Political risk

Possibility of the expropriation of assets, changes in tax policy, restrictions on the exchange of
foreign currency, or other changes in the business climate of a country.

Price risk

The risk that the value of a security (or a portfolio) will decline in the future. Or, a type of
mortgage-pipeline risk created in the production segment when loan terms are set for the borrower in advance
of terms being set for secondary market sale. If the general level of rates rises during the production cycle, the
lender may have to sell his originated loans at a discount.

Product risk

A type of mortgage-pipeline risk that occurs when a lender has an unusual loan in production or
inventory but does not have a sale commitment at a prearranged price.

Purchasing-power risk

Related: inflation risk

Rate risk

In banking, the risk that profits may decline or losses occur because a rise in interest rates forces up
the cost of funding fixed-rate loans or other fixed-rate assets.

Real exchange rates

exchange rates that have been adjusted for the inflation differential between two countries.

Regulatory pricing risk

risk that arises when regulators restrict the premium rates that insurance companies
can charge.

Reinvestment risk

The risk that proceeds received in the future will have to be reinvested at a lower potential
interest rate.

Residual risk

Related: unsystematic risk

Reverse price risk

A type of mortgage-pipeline risk that occurs when a lender commits to sell loans to an
investor at rates prevailing at application but sets the note rates when the borrowers close. The lender is thus
exposed to the risk of falling rates.


Typically defined as the standard deviation of the return on total investment. Degree of uncertainty of
return on an asset.

Risk-adjusted profitability

A probability used to determine a "sure" expected value (sometimes called a
certainty equivalent) that would be equivalent to the actual risky expected value.

Risk arbitrage

Speculation on perceived mispriced securities, usually in connection with merger and
acquisition deals. Mike Donatelli, John Demasi, Frank Cohane, and Scott Lewis are all hardcore arbs. They
had a huge BT/MCI position in the summer of 1997, and came out smelling like roses.

Risk averse

A risk-averse investor is one who, when faced with two investments with the same expected
return but two different risks, prefers the one with the lower risk.

Risk classes

Groups of projects that have approximately the same amount of risk.

Risk controlled arbitrage

A self-funding, self-hedged series of transactions that generally utilize mortgage
securities as the primary assets.

Risk indexes

Categories of risk used to calculate fundamental beta, including (1) market variability, (2)
earnings variability, (3) low valuation, (4) immaturity and smallness, (5) growth orientation, and (6) financial risk.

Risk lover

A person willing to accept lower expected returns on prospects with higher amounts of risk.

Risk management

The process of identifying and evaluating risks and selecting and managing techniques to
adapt to risk exposures.

Risk neutral

Insensitive to risk.

Risk prone

Willing to pay money to transfer risk from others.

Risk premium

The reward for holding the risky market portfolio rather than the risk-free asset. The spread
between Treasury and non-Treasury bonds of comparable maturity.

Risk premium approach

The most common approach for tactical asset allocation to determine the relative
valuation of asset classes based on expected returns.

Riskless rate

The rate earned on a riskless investment, typically the rate earned on the 90-day U.S. Treasury Bill.

Riskless rate of return

The rate earned on a riskless asset.

Riskless arbitrage

The simultaneous purchase and sale of the same asset to yield a profit.

Riskless or risk-free asset

An asset whose future return is known today with certainty. The risk free asset is
commonly defined as short-term obligations of the U.S. government.







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