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Chapter 13

2.2 Economic risk

Economic risk is the variation in the value of the business (i.e. the
present value of future cash flows) due to unexpected changes in
exchange rates. It is the long-term version of transaction risk.

For an export company it could occur because:

 the home currency strengthens against the currency in which it trades

When the exporter receives the foreign currency from its customers, it must convert it
to the home currency, which is now more expensive, meaning the exporter gets less
for each transaction.

If the exporter invoices in its home currency it is still worse off as customers will need
to buy the strong currency to pay the invoices and will be put off by the rising
exchange rate.

 a competitor’s home currency weakens against the currency in which it trades

The competitor company is now getting more of its home currency for the same
invoices and may be able to lower its prices, making it more competitive than the
home export company.

If both companies invoice in their home currencies then customers will prefer the
supplier with the weaker currency

Companies may choose to diversify their business internationally so that the
company is not overexposed to any one economy in particular.

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