What is Foreign Exchange Exposure?

It is the risk associated with

activities that involve a global firm in currencies other that its home currency. Companies must
assess and manage their foreign exchange exposures as they will face certain situations that have
a direct impact on the firms hedging decisions.
There are 3 types of exposures Multinational corporations (MNC) will face, which are:


Translation Exposureor accounting exposure is the risk of changes in value of a
companys equities when a company denominates a portion of its equities, assets, liabilities or
income in foreign currency which will be affected in value due to exchange rate changes.

Transaction Exposureis the risk of currency exchange rate changes after the company has
already entered into financial obligations where fluctuating exchange rates can lead to major
losses for companies.

Economic Exposureis a risk of fluctuating exchange rates which affects a companys
earnings, cash flow and foreign investment. Companies that have such trades with many
countries as import/export companies are at particular risk for economic exposure.

Translation
Changes of
companys asset
values affected by
the location of assets
Transaction
Related to currency
of denomination of
assets (accounts
receivable/payable)
Economic
Related to currency
of determination of
revenues and costs
Multinational
Corporations
(MNC) must assess
and mange their
foreign exchange
exposures well.






Another additional dimension of exchange rate risk involves the element of time.
In the short run, virtually all local currency prices for real goods & services remains unchanged
after an unexpected change in exchange rate.
However, in the long run, prices and costs move inversely to spot rate changes.

In reality, price adjustments takes place over a
great variety of time patterns which depends
on:
the product, market structure, nature of
competition, general business conditions,
government policies(price control)
However, all factors that determine the extent
and speed of pass-through of the unexpected
exchange rate changes are very firm-specific
and only analyzed only on a case-by-case basis
of the firm.
important to determine the time frame within
the firm cannot react to unexpected rate
changes by
(1) Rising prices (2) changing markets for input
and output (3) adjusting production and sales
volume.
exchange risk stems from the firm's
position when for a significant period its
cash flows are exposed to exchange rate
changes, rather than risk resulting from
other international involvement.
Time
Refers to the base currency in a transaction. Refers to the currency the asset is priced in.
It doesnt matter if company business practice, contract, be invoiced in, and pay for each
shipment (import/export) in its own local currency. If foreign exporter does not provide price
concessions, the cash outflow of the importer behaves like a foreign currency cash flow although
its denominated in local currency, but is determined by the relative value of foreign currency.
Cash flow even though denominated in local currency, is determined by the relative
value of the foreign currency.
Currency of
Denomination
Currency of
Determination