Economic Exposure

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A firm has economic exposure (also known as operating exposure) to the degree that its market value is influenced by unexpected exchange rate fluctuations. Such exchange rate adjustments
can severely affect the firm's market share|position with regards to its competitors, the firm's future cash flows, and ultimately the firm's value. Economic exposure can affect the present value of
future cash flows. Any transaction that exposes the firm to foreign exchange risk also exposes the firm economically, but economic exposure can be caused by other business activities and
investments which may not be mere international transactions, such as future cash flows from fixed assets. A shift in exchange rates that influences the demand for a good in some country would
also be an economic exposure for a firm that sells that good
Let's take a look at the two basic types of risk:
Currency risk is a form of risk that originates from changes in the relative valuation of currencies. These changes can result in unpredictable gains and losses when the profits or dividends
from an investment are converted from the foreign currency into U.S. dollars. Investors can reduce currency risk by using hedges and other techniques designed to offset any currencyrelated gains or losses.
For example, suppose that a U.S.-based investor purchases a German stock for 100 euros. While holding this bond, the euro exchange rate falls from 1.5 to 1.3 euros per U.S. dollar. When
the investor sells the bonds, he or she will realize a 13% loss upon conversion of the profits from euros to U.S. dollars. However, if that investor hedged his or her position by
simultaneously short-selling the euro, then the profit from the euro's decline would offset the 13% loss upon conversion.

Things to Remember about Currency Risk

Currency risk is a form of risk that originates from changes in the relative valuation of currencies.
The easiest way for individual investors can hedge against currency risk is through the use of currency-focused ETFs.

Systematic Risk - Systematic risk influences a large number of assets. A significant political event, for example, could affect several of the assets in your portfolio. It is virtually
impossible to protect yourself against this type of risk.

Unsystematic Risk - Unsystematic risk is sometimes referred to as "specific risk". This kind of risk affects a very small number of assets. An example is news that affects a specific
stock such as a sudden strike by employees. Diversification is the only way to protect yourself from unsystematic risk. (We will discuss diversification later in this tutorial).

Credit or Default Risk - Credit risk is the risk that a company or individual will be unable to pay the contractual interest or principal on its debt obligations. This type of risk is of
particular concern to investors who hold bonds in their portfolios. Government bonds, especially those issued by the federal government, have the least amount of default risk and
the lowest returns, while corporate bonds tend to have the highest amount of default risk but also higher interest rates. Bonds with a lower chance of default are considered to
be investment grade, while bonds with higher chances are considered to be junk bonds. Bond rating services, such as Moody's, allows investors to determine which bonds are
investment-grade, and which bonds are junk. (To read more, see Junk Bonds: Everything You Need To Know, What Is A Corporate Credit Rating and Corporate Bonds: An
Introduction To Credit Risk.)

Country Risk - Country risk refers to the risk that a country won't be able to honor its financial commitments. When a country defaults on its obligations, this can harm the
performance of all other financial instruments in that country as well as other countries it has relations with. Country risk applies to stocks, bonds, mutual funds, options and futures
that are issued within a particular country. This type of risk is most often seen in emerging markets or countries that have a severe deficit. (For related reading, see What Is An
Emerging Market Economy?)

Foreign-Exchange Risk - When investing in foreign countries you must consider the fact that currency exchange rates can change the price of the asset as well. Foreign-exchange
riskapplies to all financial instruments that are in a currency other than your domestic currency. As an example, if you are a resident of America and invest in some Canadian stock in
Canadian dollars, even if the share value appreciates, you may lose money if the Canadian dollar depreciates in relation to the American dollar.

Interest Rate Risk - Interest rate risk is the risk that an investment's value will change as a result of a change in interest rates. This risk affects the value of bonds more directly
than stocks. (To learn more, read How Interest Rates Affect The Stock Market.)

Political Risk - Political risk represents the financial risk that a country's government will suddenly change its policies. This is a major reason why developing countries lack foreign
investment.

Market Risk - This is the most familiar of all risks. Also referred to as volatility, market risk is the the day-to-day fluctuations in a stock's price. Market risk applies mainly to stocks
and options. As a whole, stocks tend to perform well during a bull market and poorly during a bear market - volatility is not so much a cause but an effect of certain market forces.
Volatility is a measure of risk because it refers to the behavior, or "temperament", of your investment rather than the reason for this behavior. Because market movement is the
reason why people can make money from stocks, volatility is essential for returns, and the more unstable the investment the more chance there is that it will experience a dramatic
change in either direction.
As you can see, there are several types of risk that a smart investor should consider and pay careful attention to.

Meaning and definition of currency risk

Currency risk refers to a risk form arising from the changes price of one currency as compared to another currency. Whenever companies or investors possess assets or business operations
across national boundaries, they experience currency risk if their positions are not prevaricated. Currency risk is also referred as exchange rate risk. Putting it simple, currency risk can be
defined as the possibility that currencydepreciation will show negative effect on the value of assets, investments, and their related interest and dividend payment streams, specifically those
securities denominated in foreign currency.
As illustrated by Investopedia through an example, if a US investor has stock in Canada, the return realized by you will be affected by the change in [price of stock as well as the change in
value of Canadian dollar against the US dollar. Therefore, if a 15% return is realized on the Canadian stock but the Canadian dollar deflates 15% against the US dollar, this will generate no
profit at all. Moreover, as per the academic studies of currency risk, although without complete certainty, that investors facing currency risk are not rewarded with greater potential returns,
implying that it is essentially an unnecessary risk to bear.
Types of currency risk

Generally, there are two basic types of currency risk:

Transaction risk
This type of risk is the one related to an unfavorable change in the exchange rate over a certain time period.

Translation risk
This risk type is an accounting concept. It is relative to the amount of assets held in foreign currencies. Alterations in exchange rate over a certain period will provide an inaccurate report, and
thus the assets are generally balanced by borrowings in the specific currency.
Consequences of currency risk
Currency risk has been demonstrated to be predominantly significant and damaging for very large, rarity investment projects, generally referred as megaprojects. This is for the reason that
such projects are generally financed by huge debts nominated in currencies distinctive from the currency of the home country of the debt owner. These type of megaprojects have been
demonstrated as prone to ending up as what is commonly known as debt trap resulting from currency risk, i.e. unexpected changes in the exchange rates.

The Importance of Cash Management

Thu Apr 2, 2009 9:45am EDT

Cash Management
Business analysts report that poor management is the main reason for business failure. Poor cash management is probably the most frequent stumbling block for entrepreneurs. Understanding
the basic concepts of cash flow will help you plan for the unforeseen eventualities that nearly every business faces.
Cash vs. Cash Flow
Cash is ready money in the bank or in the business. It is not inventory, it is not accounts receivable (what you are owed), and it is not property. These can potentially be converted to cash, but
can't be used to pay suppliers, rent, or employees.
Profit growth does not necessarily mean more cash on hand. Profit is the amount of money you expect to make over a given period of time, while cash is what you must have on hand to keep
your business running. Over time, a company's profits are of little value if they are not accompanied by positive net cash flow. You can't spend profit; you can only spend cash.

Cash flow refers to the movement of cash into and out of a business. Watching the cash inflows and outflows is one of the most pressing management tasks for any business. The outflow of
cash includes those checks you write each month to pay salaries, suppliers, and creditors. The inflow includes the cash you receive from customers, lenders, and investors.
Positive Cash Flow
If its cash inflow exceeds the outflow, a company has a positive cash flow. A positive cash flow is a good sign of financial health, but is by no means the only one.
Negative Cash Flow
If its cash outflow exceeds the inflow, a company has a negative cash flow. Reasons for negative cash flow include too much or obsolete inventory and poor collections on accounts receivable
(what your customers owe you). If the company can't borrow additional cash at this point, it may be in serious trouble.
What Are the Components of Cash Flow?
A "Cash Flow Statement" shows the sources and uses of cash and is typically divided into three components:
Operating Cash Flow Operating cash flow, often referred to as working capital, is the cash flow generated from internal operations. It comes from sales of the product or service of your
business, and because it is generated internally, it is under your control.
Investing Cash Flow Investing cash flow is generated internally from non-operating activities. This includes investments in plant and equipment or other fixed assets, nonrecurring gains or
losses, or other sources and uses of cash outside of normal operations.
Financing Cash Flow Financing cash flow is the cash to and from external sources, such as lenders, investors and shareholders. A new loan, the repayment of a loan, the issuance of stock,
and the payment of dividend are some of the activities that would be included in this section of the cash flow statement.
How Do I Practice Good Cash Flow Management?
Good cash management is simple. It involves:
1. Knowing when, where, and how your cash needs will occur
2. Knowing the best sources for meeting additional cash needs
3. Being prepared to meet these needs when they occur, by keeping good relationships with bankers and other creditors
The starting point for good cash flow management is developing a cash flow projection. Smart business owners know how to develop both short-term (weekly, monthly) cash flow projections to
help them manage daily cash, and long-term (annual, 3-5 year) cash flow projections to help them develop the necessary capital strategy to meet their business needs. They also prepare and
use historical cash flow statements to understand how they used money in the past.