ACCA Financial Management (F9) Certification Practice Exam

What type of risk assesses the effect of exchange rate movements on a company's international competitiveness and cash flows?

1. Translation risk

2. Transaction risk

3. Economic risk

4. Purchasing power risk

The correct answer is: Economic risk

The correct answer pertains to economic risk, which refers to the impact of exchange rate fluctuations on a company's competitiveness and its overall cash flow. This type of risk considers how changes in exchange rates can affect the market position of a company involved in international trade. When a currency depreciates or appreciates, it can alter the relative prices of goods and services, influencing demand and supply dynamics in various markets. Consequently, economic risk emphasizes the broader economic implications and ongoing market conditions rather than just specific transactions or accounting measurements. Translation risk, on the other hand, deals with the accounting implications of converting foreign assets and liabilities into a domestic currency for financial reporting purposes, while transaction risk focuses specifically on the risk arising from the time gap between entering a transaction and settling it, which could expose a company to exchange rate fluctuations. Purchasing power risk is related to inflation and how it erodes the purchasing power of currency over time, which is a different concern altogether. Thus, economic risk is the most fitting concept when analyzing how exchange rate movements affect a company’s cash flows and international competitiveness.