There are three types of exchange rate risk, including
•Translation risk 折算风险
Where the performance of an overseas subsidiary in home based currency is distorted in consolidated financial statements due to change in exchange rates.
•Economic risk 经济风险
It refers to the variation in the value of the business in long term.
•Transaction risk 交易风险
It refers to the risk of an exchange rate changing between the transaction and the subsequent settlement date.
Reason for exchange rate fluctuated
•PPPT (Purchasing Power Parity Theory) 购买力平衡理论
It involves that the rate of exchange between the two currencies depends on the relative inflation rate within the respective countries. PPPT is based on “the law of one price”
Formula
S1=S0× (1+hc) / (1+hb)
•IRPT(Interest Rate Parity Theory) 利率平价理论
It involves that the difference between the spot and the forward exchange rate is equal to the differential between interest rates available in two currencies.
The forward rate is a future exchange rate, agreed now, for buying or selling an amount of currency on an agreed future date.
•International Fisher Effect
The International Fisher Effect assumes that all countries will have the same real interest rate although nominal or money rates may differ due to expected inflation rates. Thus the interest rate differential between two countries should be equal to the expected inflation differential.
Formula
(1+i)=(1+r)(1+h)
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