Page 10 - SCS May 2018 - Day 2 Suggested Solutions

CIMA MAY 2018 – STRATEGIC CASE STUDY

CHAPTER NINE

EXERCISE 1

Email

To: Martine Andels
From: Senior Manager
Subject: Currency Risk

The purpose of this email is to consider the three different types of currency risk, and how they
might be mitigated, if appropriate, by Couchweb.

Translation risk

This is the currency risk of holding foreign assets or liabilities.

If Couchweb holds any foreign assets or liabilities, then it is exposed to translation risk.
Translation risk does not tend to be mitigated by companies as it does not represent a real
loss/gain of cash but is a “book entry”.

Transaction risk

This is the risk of buying and selling on credit in foreign currency.

Transaction risk could be significant for Couchweb (though it should be remembered that the risk
may be upside as well as downside).

Couchweb will be buying content in various currencies on credit. The company may be expecting
to pay a certain amount to a foreign production company when the arrangement is made to
purchase the content, however when the payment dates arrives, the exchange rate may have
moved so that the payments are higher (or lower) than expected. The company is also affected by
this risk, as the money received from overseas subscribers will also be subject to currency
movement.

Couchweb may use a mixture of internal and external hedging. Internal methods are arranged by
Couchweb itself whereas external methods would use an exchange or bank.

Internal methods may include simply pay early or as late as possible. This is known as “leading and
lagging”. Its effectiveness, however, depends on the ability to predict the exchange rate.

Netting is another popular form of internal hedging; however the extent it can be used by
Couchweb would need some further investigation. It depends on there being an offsetting foreign
receipt to net off against a payment.

Finally, Couchweb may be able arrange to deal with all suppliers so that payments are made in its
home currency of M$. These arrangements tend to work if one party has strong bargaining

66 KAPLAN PUBLISHING