Transaction risk refers to the time delay between entering into a contract, settling, and paying more than expected as exchange rate changes.

• A. Time delay between entering into a contract, settling, and paying more than expected as exchange rate changes
• B. Long-term interest rate shifts
• C. Domestic price level changes
• D. Hedging costs

Answer: (A)

Transaction risk arises from the possibility that exchange rate movements during the period between agreeing a contract and settling the payment will change the domestic currency amount required. Because the cash flows are delayed, the rate at settlement can differ from the rate at contract signing, so the domestic-cost of the transaction can be higher (or lower) than anticipated. This makes the exposure directly tied to the time lag and FX volatility, which is exactly what the option describes.

In contrast, long-term interest rate shifts relate to interest rate risk, domestic price level changes to inflation or price risk, and hedging costs to the expense of mitigating risk—none of these capture the specific timing-related FX exposure of a contract from signing to settlement.