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The risk management process: Business strategy and tactics - Essay Example

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The risk management process: Business strategy and tactics

Foreign exchange risk is the unanticipated changes in the exchange rates that could lead to losses or gains for a firm. Multinational companies face three different types of foreign exchange risk: transaction risk, translation risk and economic risk (Eun & Resnick 2005). Translation risk is the risk that occurs when firms consolidate the financial statements foreign operations with that of the home country. For consolidation purposes, the financial statements of subsidiaries are restated from the foreign currencies to the functional currency. The translation risk is therefore the accounting risk involved when restating the foreign currencies to the functional currency for consolidation purposes (Eun & Resnick 2005). Transaction risk on the other hand is the risk of changes in exchange rates on the value of foreign currency transaction that the firm had entered into. Since multinational companies engage in credit transactions where payment for goods and services are made at a future date, there is a likelihood that the exchange rate at the transaction date will be different from the exchange rate on the date when the financial obligations are settled. The differences in the exchange rates may make multinational enterprises earn different cash amounts to the cash expected on the transaction date. Future cash flows of the enterprises are therefore at risk. Finally, economic risk is the effect of foreign exchange changes on the value of the firm. It is the long term effect of exchange rate fluctuations on the value of firm future expected cash flows. It is important to note that economic risk is difficult to determine because future cash flows are hard to anticipate. In order to clearly demonstrate how the foreign exchange fluctuations affect the contracts, cash flows and market values of a firm, the risk of foreign exchange fluctuation on Unilever has been analysed. Unilever is a leading supplier of fast moving consumer goods in the globe (Unilever 2010). The products are in the line of hygiene, nutrition, personal care and other products which make people feel good and improve the quality of life. The turnover of is generated in emerging markets and in the developing economies (Unilever 2010). This global nature of operations exposes the company to operational, political and economic risks. These risks could adversely affect the cash flows; asset base, turnover and profit margin hence impair the shareholders value maximisation goal. Moreover, because Unilever prepares consolidated financial statements in Euros, it is exposed to translation risk of the subsidiaries net assets (Unilever 2010). Unilever is as well faced with the threat of exchange controls by individual countries that constrains its imports ability paid by foreign currency (Unilever 2010). During the economic recession, the Euro declined significantly in the various countries of operations (Eun & Resnick 2005). This threatened the profitability of Unilever as the economic recession made most regions incur colossal losses from the foreign exchange fluctuation. It thus made Unilever to react swiftly to the risk in foreign exchange exposures by adopting hedging techniques. The report further discusses the hedging techniques that were used by the finance managers to mitigate if not eradicate the adverse impact of the fluctuations on the firms profitability and operations. The paper has also come up with the various recommendations that ...Show more


INTERNATIONAL FINANCIAL STRATEGIES Date Introduction The era of globalisation has seen businesses extend their operations in foreign markets making them be classified as multinational enterprises. In this course, multinational companies face many challenges…
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The risk management process: Business strategy and tactics essay example
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