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ACCA Applied Skills · Financial Management · The nature and types of risk and approaches to risk management

A UK company has a contract to receive US dollars from a customer in three months' time. It has not hedged the exposure. Which type of foreign exchange risk does this most directly represent?

This is transaction risk. The company will receive a fixed dollar sum in three months, so the sterling it ends up with depends on the exchange rate at settlement. Translation risk relates to consolidating foreign net assets, and economic risk to long-term competitiveness.

  1. ATranslation risk, because the dollar receipt will be consolidated into the group accounts
  2. BTransaction risk, because the sterling value of a future dollar cash flow may change before settlementCorrect
  3. CEconomic risk, because the company's long-term competitive position will be altered permanently
  4. DBasis risk, because the dollar receipt and the sterling cost are priced on different bases

Explanation

A known foreign currency cash flow due on a specific future date creates transaction risk: the sterling amount received depends on the spot rate at settlement. Translation risk concerns restating foreign assets and liabilities in consolidation, which is not what a single receivable involves. Economic risk is about long-run changes in competitiveness, not one contracted receipt.

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