What is Economic Risk?
Economic Risk is a more broad risk that is difficult to quantify. The risk usually occurs when currency volatility affects the firm’s cash flows or its competitive standing within the domestic market. Let’s talk about a company operating in Canada. Changes in the Canadian exchange rate may make it advantageous for a foreign competitor to enter the Canadian market and negatively impact the Canadian firm. There are multiple ways of hedging economic risk. One possible way is from an operational perspective by relocating production facilities or expanding sales overseas.
Examples of Economic Risk:
For example, for cash flows, if Disney World in the United States incurs all revenue and expenses in USD, a decline in the USD relative to all currencies may be beneficial if it induces more foreign travellers to visit the United States and Disney World.
Why is Economic Risk significant?
Economic risk is considered a macro-level risk that may significantly impact all financial markets. As we have seen during various recessions, an economic risk also leads to uncertainty and volatility in the financial markets. Hence, it is critical to understand the economic risk and its linkages to the financial markets and associated risks.