Currency Risk Sharing

Definition of 'Currency Risk Sharing '


A form of hedging currency risk in which the two parties to a transaction agree to share the risk from exchange rate fluctuation. Currency risk sharing generally involves a price adjustment clause, wherein the base price of the transaction is adjusted if the exchange rate fluctuates beyond a specified neutral band or zone. Risk sharing thus occurs only if the exchange rate at the time of transaction settlement is beyond the neutral band, in which case the two parties split the profit or loss.  By fostering cooperation between the two parties, currency risk sharing eliminates the zero-sum game nature of currency fluctuations, in which one party benefits at the expense of the other.

Investopedia explains 'Currency Risk Sharing '


Currency risk sharing depends on the relative bargaining position of the two parties to the transaction and their willingness to enter into such a risk-sharing arrangement. If the buyer (or seller) can dictate terms and perceives there is little risk of their profit margin being affected by currency fluctuation, they may be less willing to share the risk.

For example, assume a hypothetical U.S. firm called PowerMax is importing 10 turbines from a European company EC, priced at EUR $1 million each for a total order size of EUR $10 million. Owing to their longstanding relationship, the two companies agree to a currency risk sharing agreement. Payment by PowerMax is due in three months, and the company agrees to pay EC at a spot rate in three months of EUR 1 = $1.30, which means that each turbine would cost it $1.30 million for a total payment obligation of $13 million. The currency risk sharing contract between EC and USF specifies that the price per turbine will be adjusted if the euro trades below 1.25 or above 1.35. Thus, a price band of 1.25 to 1.35 forms the neutral zone over which currency risk will not be shared.

In three months, assume the spot rate is EUR 1 = $1.38. Instead of PowerMax paying EC the equivalent of $1.38 million (or EUR 1 million) per turbine, the two companies split the difference between the base price of $1.30 million and the current price (in dollars) of $1.38 million. The adjusted price per turbine is therefore the euro equivalent of $1.34 million, which works out to EUR 971,014.50 at the current exchange rate of 1.38. Thus, PowerMax has obtained a price discount of 2.9%, which is one-half the 5.8% depreciation in the dollar versus the euro. The total price paid by PowerMax to EC is therefore EUR $9.71 million, which at the exchange rate of 1.38 works out to exactly 13.4 million.

On the other hand, if the spot rate in three months is EUR 1 = 1.22, instead of PowerMax paying EC the equivalent of $1.22 million per turbine, the two companies split the difference between the base price of $1.30 million and the current price of $1.22 million. The adjusted price per turbine is therefore the euro equivalent of $1.26 million, which works out to EUR 1,032,786.90 (at the current exchange rate of EUR 1.22). Thus, PowerMax pays an additional 3.28% per turbine, which is one-half of the 6.56% appreciation in the dollar.



comments powered by Disqus
Hot Definitions
  1. Amplitude

    The difference in price from the midpoint of a trough to the midpoint of a peak of a security. Amplitude is positive when calculating a bullish retracement (when calculating from trough to peak) and negative when calculating a bearish retracement (when calculating from peak to trough).
  2. Ascending Triangle

    A bullish chart pattern used in technical analysis that is easily recognizable by the distinct shape created by two trendlines. In an ascending triangle, one trendline is drawn horizontally at a level that has historically prevented the price from heading higher, while the second trendline connects a series of increasing troughs.
  3. National Best Bid and Offer - NBBO

    A term applying to the SEC requirement that brokers must guarantee customers the best available ask price when they buy securities and the best available bid price when they sell securities.
  4. Maintenance Margin

    The minimum amount of equity that must be maintained in a margin account. In the context of the NYSE and FINRA, after an investor has bought securities on margin, the minimum required level of margin is 25% of the total market value of the securities in the margin account.
  5. Leased Bank Guarantee

    A bank guarantee that is leased to a third party for a specific fee. The issuing bank will conduct due diligence on the creditworthiness of the customer looking to secure a bank guarantee, then lease a guarantee to that customer for a set amount of money and over a set period of time, typically less than two years.
  6. Degree Of Financial Leverage - DFL

    A ratio that measures the sensitivity of a company’s earnings per share (EPS) to fluctuations in its operating income, as a result of changes in its capital structure. Degree of Financial Leverage (DFL) measures the percentage change in EPS for a unit change in earnings before interest and taxes (EBIT).
Trading Center