Exchange-rate risk and exchange-rate regimes

In Chapter 6 we introduced a technique to find a discount rate that is commensurate with the riskiness of future cash flows. This discount reflects investors’ impatience to consume, inflation and uncertainty over future cash flows. When a company is trading internationally a further risk needs to be considered – transaction exposure. Transaction exposure is the risk faced by companies that trade internationally, when exchange rates change after a company has entered into an agreement, leading to higher domestic currency costs or lower domestic currency revenue.

However, different countries operate various exchange-rate regimes. Below we detail the exchange-rate regime for (i) China, (ii) the Czech Republic, (iii) France, (iv) the UK and (v) the United Arab Emirates.

China

China officially maintains a de jure managed floating exchange rate arrangement with a view to keeping the RMB exchange rate stable at an adaptive and equilibrium level based on market supply and demand with reference to a basket of currencies to preserve the stability of the Chinese economy and financial markets. The floating band of the RMB's trading prices is 2% against the U.S. dollar in the interbank foreign exchange market—i.e., on each business day, the trading prices of the RMB against the U.S. dollar in the market may fluctuate within a band of ±2% around the midrate released that day by China's Foreign Exchange Trading System (CFETS).

Czech Republic

The de jure exchange rate arrangement is floating. The external value of the koruna is determined by supply and demand in the interbank foreign exchange market, in which the Czech National Bank (CNB) participates.

France

The de jure exchange rate arrangement of the euro area is free floating. France participates in a currency union (EMU) with, as of January 1, 2015, 18 other members (previously 17) of the EU and has no separate legal tender. The euro, the common currency, floats freely and independently against other currencies.

United Kingdom

The de jure and de facto exchange rate arrangements are free floating. The exchange rate of the pound sterling is determined on the basis of supply and demand in the foreign exchange market.