Define each of the following terms: d. Exchange rate risk; convertible currency; pegged exchange rate
Define each of the following terms:
Exchange rate risk: Exchange rate risk refers to variation arising in cash flows due to fluctuation in exchange rates between currencies over a period of time. When a multinational corporation operates in more than one country, it is subject to certain risks. When there is a change in the currency exchange rate, the incoming foreign cash flows of the company get affected. The value of foreign cash flows may get appreciated or even devalued. This risk arising due to change in foreign exchange rate, is called “Exchange rate risk”.
Convertible currency: A convertible currency is the one which can be traded in currency markets and can be redeemed at the current market rates. While dealing in the foreign markets, a company needs to exchange the home currency with foreign currency. The currency that can be traded in the international market without any government restrictions is called a convertible currency. It also has alternative references like hard currency or fully convertible currency.
Pegged exchange rate: The exchange rate at which a country links its currency to another currency or group of currencies is known as pegged exchange rate. Pegging the currency stabilizes the rate of exchange between the two countries. For instance, the Hong Kong dollar has been pegged to US dollars since the 1980s. This enables the domestic markets to access the international markets with lesser risk.