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Exchange Rate Risk/Exposure

Please explain what are the three types of exchange rate risk or exposure.

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1) The first type of risk in the transaction risk which arises during foreign exchange transactions are the risks due to adverse fluctuations in exchange rates. Such risks can be minimized by using wide range of hedging tools and mechanisms available in the international financial markets. Such tools include forward contracts, options such as put and call options, interest rate swaps,etc. The use of such hedging mechanism limits the risk exposure in such transactions.

A forward rate agreement (FRA) is a contract to buy or sell currency at an agreed upon exchange rate at a specific date in the future.

A U.S. exporter who has contracted with a foreign buyer to be paid in the foreign buyer's currency later, can contract now to sell this currency to a bank or other financial institution for a predetermined amount in U.S. dollars.

If the exchange rate has moved against the exporter between the date of the contract and the settlement date, he is protected. Conversely, he foregoes the potential windfall of a favorable exchange rate movement. Thus, forwards allow an exporter to ...

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Please explain what are the three types of exchange rate risk or exposure.

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