Transaction risk

Definition

Transaction risk is the potential for financial loss due to fluctuations in exchange rates between the initiation and settlement of a transaction. It directly affects any business or individual dealing in foreign currencies.

5 Must Know Facts For Your Next Test

1. Transaction risk arises from the time lag between contract agreement and actual payment.
2. This type of risk can impact both importers and exporters who engage in international trade.
3. Forward contracts, options, and futures are common tools used to hedge against transaction risk.
4. Transaction risk can lead to either gains or losses depending on currency movements.
5. Effective management of transaction risk is crucial for maintaining profitability in international operations.

Review Questions

• What is transaction risk and how does it occur?
• Name three financial instruments used to hedge against transaction risk.
• Why is managing transaction risk important for companies involved in international trade?

Related terms

Exchange_Rate_Risk: The broader category of risks arising from changes in currency exchange rates affecting all aspects of financial transactions.

Hedging:

A strategy used to offset potential losses by taking an opposite position in a related asset.

Forward_Contract: An agreement to buy or sell an asset at a predetermined future date for a price specified today, commonly used to mitigate transaction risk.