Explanation:
A is FALSE. There is a timing problem if we attempt to net translation (LA) risk against transaction (AC) risk.
Per GARP: "It is sometimes recommended that translation risk be netted against transaction risk, but this is not appropriate. As we have described, forward contracts are very useful for hedging transaction risk. Transaction risk exposures should be estimated month by month, and each month's exposure can be hedged separately. However, it only makes sense to hedge translation exposure on one future date. For example, it would be over-hedging to hedge the FX exposure to the value of the assets in one and in two years because the price increase (or decrease) over the first year is then considered twice."
In regard to (B), (C), and (D), each is TRUE:
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The three types of foreign exchange risk are transaction risk, translation risk, and economic risk. Due to the textual resemblance between the first two, we will denote them as transaction (AC) and translation (LA) risk. In regard to these risks, each of the following statements is true EXCEPT which is false?
A
a) Translation (LA) risk, in general, should be netted against transaction (AC) risk
B
b) Translation (LA) risk does not affect the firm's cash flow but might have a big effect on reported earnings
C
c) Translation (LA) risk can be avoided by financing assets in the foreign country with borrowings in that same country
D
d) Economic risk is harder to quantify than either transaction (AC) or translation (LA) risk but can affect the firm's future cash flows via supply/demand or competitive dynamics
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