Transaction Exposure





Week 5 Discussion 1-Transaction Exposure

What is a foreign exchange exposure?

Foreign Exchange Exposure is the risk that is affiliated with activities, which involve a multinational in currencies different from its own. In particular, it is the amount of threat posed to a global firm by any alteration in the value of a certain currency. Therefore, any reevaluation of a currency influences the performance of a multinational company whereby a negative trajectory could reduce the firm’s profitability (Mehta 1). Consequently, it affects the cash flow, rates of loan settlements in foreign currencies, its competitiveness in the global market due to diminished returns and the market price of the business as well.

What are the different types of exposures?

Transaction exposure is a short-term risk to contracts that a company has already committed itself. Therefore, whenever a company is engaged in a transaction as either a buyer or seller, that would require the transfer of foreign currency, it is exposed to this risk. In most instances, the supplier of raw materials has the upper hand when appreciation of the currency occurs and the consumer has to pay for it in the host’s currency. For example, maturing financial assets, accounts payables, and receivables denominated in foreign currencies are part of this category. Financial liabilities that are also maturing are incorporated as well.

Translation exposure highlights a loss or gain that arises from the translation or conversion of financial statements of a branch of a multinational located overseas. Therefore, it is accounting oriented and seeks to determine the precise effect of currency changes have on the overall performance of a subsidiary due to their requirement to file reports for assessment by the parent company (Sandler 1). As such, the impact of the combined operations on the corporation’s balance sheet is scrutinized. Therefore, the consolidated financial records would provide a clearer picture of the loss or gain.

Economic exposure is a long-term consequence of transaction exposure whereby a company is continuously exposed to changes in foreign exchange rates due to its permanent location of operations. In most cases, it results from involvement in Foreign Direct Investment activities in which operating costs and operating income are incurred. Consequently, it can be classified as a future risk.

How a transaction exposure can be hedged?

Hedging would require the business to make its position about the purchase of an asset/liability known in advance in order to cushion it from changes to the value of the foreign exchange currencies (Wilkinson 1). In so doing, the corporation would be aiming to reduce the amount of losses to be incurred in case of a decline in value while seeking a boost in its balance sheet in the event of a climb.

What are the different types of hedging transaction exposures?

The company may purchase foreign currency or use currency futures and swaps to minimize the amount of transaction exposure. In fact, the firm agrees to buy/sell a foreign currency at an exact time in future at a price that is currently agreeable to both parties. In addition, it could use the options market to hedge funds by incorporating derivatives that provide the holder with the right to purchase/sell currencies at a predetermined price. However, they do not make this requirement obligatory (Prasad 1). Moreover, contingent exposure could be used as well especially in dealing with third parties due to the uncertainty involved. In particular, the firm would hedge its duty to make the currency transactions pegged on the accomplishment of the third party actions such as acceptance of a tender/bid. Afterwards, the same options market procedures explained above would be implemented.



Works Cited

Mehta, Vijay. Foreign Exchange Exposure. 27 August 2012. Web. 4 February 2015.

Prasad, Manohar. Foreign Currency Exposure and Risk Management. 23 November 2011. Web. 4 February 2015.

Sandler, Kevin. Three Types of Foreign Exchange Exposure. Demand Media, 2007. Web. 4 February 2015.

Wilkinson, Jim. Transaction Exposure. The Strategic CFO, 24 July 2013. Web. 4 February 2015.

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