What is Transaction Risk?
Whenever there is an involvement of foreign exchange, there is always a risk of currency conversion involved. Hence, we refer to Transaction Risk as the risk when the cash flow of one currency must be exchanged for another at a future date to settle a specific transaction. It can occur within a receivable or a payable context for a firm.
Examples of Transaction Risk:
Let’s take an example of an importer who has to pay the foreign currency in exchange for goods or services at a future date. The importer has a risk if that currency appreciates. For example, a U.K. company must pay CAD 100 million in six months. The spot exchange rate is GBPCAD 1.7165, and the six-month forward exchange rate is GBPCAD 1.7350. The cost of buying the CAD forward is higher than in the spot market, but the spot market is not relevant because the CAD is not yet needed. The forward market does allow the U.K.-based company to lock in the GBP cost of the transaction at 1.7350.