Chapter 5Hedging Foreign Exchange Risk
Foreign exchange risk is the most common financial risk. Entities that have foreign currency transactions and operations are exposed to the risk that exchange rates can vary, causing unwanted fluctuations in earnings and in cash flows. Chapters 5, 6 and 8 deal with the accounting implications of FX hedges through the extensive use of cases. Chapter 5 covers the hedging of anticipated sales and purchases and their resulting receivables and payables. Chapter 6 examines the hedging of net investments in foreign entities. Chapter 8 covers the hedging of foreign currency denominated debt.
The accounting guidance on FX exposures and their hedging is included in two IFRS standards: IFRS 9 Financial Instruments and IAS 21 The Effects of Changes in Foreign Exchange Rates. A summary of IFRS 9 was given in Chapters 1 and 2. Some of the concepts of IAS 21 are outlined in this chapter and Chapter 6.
5.1 TYPES OF FOREIGN EXCHANGE EXPOSURE
An exposure to FX risk results mainly from the following transactions:
- foreign currency forecasted sales and purchases, and receivables and payables resulting from such transactions;
- interest and principal repayment on foreign currency denominated debt and deposits;
- revaluation of foreign currency denominated equity investments;
- receipt of dividends from foreign investments;
- translation of profits of foreign operations;
- translation of net assets of foreign operations;
- competitive risk.
Competitive risk is the risk ...
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