Exchange Rate Risk Assignment Example | Topics and Well Written Essays - 1250 words

Exchange Rate Risk - Assignment ExampleThe term mass meeting rate risk is used to define the possibility that, because of fluctuation currency values, companies dealing in more than one currency may end up with more or less of a profit. In the Bruce partys case, a fluctuation of 1.45733 Euros per Sterling denotes a negative exchange rate risk. Put more simply, the Bruce Company must pay the French company a total sum of 4.48 gazillion Euros in quaternion equal installments of 1.12 million Euros. Because the Sterling is currently stronger than the Euro, Bruce Company will loose money during four furcate transactions in which their stronger currency is converted to the weaker currency.Thus, Bruce Company must discover a way to prorogue against the exchange rate risk, or take out another(prenominal) investment specifically to reduce or eliminate this risk. One way to hedge against this risk is allowing the sterling to accrue involution in a money market account. Because interes t in a British account is and will continue to be greater than that of a French account, a simple rate of return calculation will image that the British account will yield higher profit For instance, consider one payment of 1.12 million Euros kept in a British Money Market account for three months. 1.12 Million________ = 768, 5291.45733ROR= 768, 529 ( .25 + 4.59375 ) ROR= 3,722,562.34375If, on the other hand, the Euros were kept in a French Money Market account for three months, the followers results would occurROR= 1.12 million (.25 + 2.75000) ROR= 3,360,000It is obvious, therefore, that victimization British Money Market transactions is especially advantageous in this type of scenario. The extra money accumulated in the account may compensate for, or at least soften, the blow of exchange rate risk, depending on the floating rates at the time. There is a significant risk involved in long term Money Market account investment, however, in that they too are subject to fluctuating ex change rates. If exchange rates vary drastically in while interest is accruing, lower interest rates might, in the he end, have generated more gravid once the money is exchanged for the original currency. 1Interest Rate Risk When the Bruce Company took out its loan, its choice of a fixed interest rate was an attempt to avoid great interest rate risk, as interest rates were rising. Now that the financial advisor and others believe that the interest rate is falling, howerver, and interest rate trade is beginning to look beneficial. A company uses an interest rate swap when it exchanges its interest rate for that of another party. By swapping interest rates, companies allow themselves some freedom from climbing interest rates. In order to determine whether or not an interest rate swap is beneficial, however, the zero-coupon bonds calculations must be performed.If interest is compounded annually, using the rate of returns formula, interest rates for zero-coupon bonds are as followesOn e Year Two Years three Years Four Years 4.675= (1+ i) 4.