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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
dollars.


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.



Asset-specific Risk

The amount of total risk that can be eliminated by diversification by
creating a portfolio. Also known as company-specific risk or
unsystematic risk.


Bankruptcy risk

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


Exchange Risk Image 2

Basis risk

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


Beta risk

risk of a firm measured from the standpoint of an investor who holds a highly diversified portfolio.


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


Companyspecific Risk

See asset-specific 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
stock.


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


Credit Risk

Financial and moral risk that an obligation will not be paid and a loss will result.


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
transaction.


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.


Effective Exchange Rate

The weighted average of several exchange rates, where the weights are determined by the extent of our trade done with each country.


Equation of Exchange

The quantity theory equation Mv = PQ.


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.


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)


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

Amount of one currency needed to purchase one unit of another.


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 Rate, Nominal

The price of one currency in terms of another, in this book defined as number of units of foreign currency per dollar.


Exchange Rate, Real

The nominal exchange rate corrected for price level differences.


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.


expectations theory of exchange rates

Theory that expected spot exchange rate equals the forward rate.


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.


financial risk

risk to shareholders resulting from the use of debt.


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 Exchange Rate

An exchange rate held constant by a government promise to buy or sell dollars at the fixed rate on the foreign exchange market.


Flat price risk

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


Flexible Exchange Rate

An exchange rate whose value is determined by the forces of supply and demand on the foreign exchange market.


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 Exchange Rate

See flexible exchange rate.


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

The currency of a foreign 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 Market

A worldwide market in which one country's currency is bought or sold in exchange for another country's currency.


Foreign Exchange Reserves

A fund containing the central bank's holdings of foreign currency or claims thereon.


Foreign exchange swap

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


Forward Exchange Market

A market in which foreign exchange can be bought or sold for delivery (and payment) at some specified future date but at a price agreed upon now.


Forward exchange rate

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


forward rate of exchange

exchange rate for a forward transaction.


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.


High-Risk Small Business

Firm viewed as being particularly subject to risk from an investors perspective.


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.


Interest Rate Risk

Possibility that interest rates will rise during the term of a loan thereby increasing the annual cost of borrowing.


judgmental method (of risk adjustment)

an informal method of adjusting for risk that allows the decision maker
to use logic and reason to decide whether a project provides
an acceptable rate of return


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


Market Risk

The amount of total risk that cannot be eliminated by portfolio
diversification. The risk inherent in the general economy as a
whole. Also known as systemic risk.


market risk

Economywide (macroeconomic) sources of risk that affect the overall stock market. Also called systematic risk.


Market Risk

The part of security's risk that cannot be eliminated by diversification. It is measured by the beta coefficient.


market risk premium

risk premium of market portfolio. Difference between market return and return on risk-free Treasury bills.


Medium of Exchange

Any item that can be commonly exchanged for goods and services.


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.


operating risk (business risk)

risk in firm’s operating income.


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.



 

 

 

 

 

 

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