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Questions and Answers
What is the primary concern of transaction exposure?
What is the primary concern of transaction exposure?
What is the purpose of invoicing in domestic currency?
What is the purpose of invoicing in domestic currency?
What is the benefit of leading in foreign currency transaction risks?
What is the benefit of leading in foreign currency transaction risks?
What is a characteristic of operating exposure?
What is a characteristic of operating exposure?
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Why is lagging not an effective risk reduction strategy?
Why is lagging not an effective risk reduction strategy?
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What is a common practice in certain commodity markets?
What is a common practice in certain commodity markets?
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What is the goal of managing foreign currency transaction risks?
What is the goal of managing foreign currency transaction risks?
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What is a technique used to reduce foreign currency transaction risks?
What is a technique used to reduce foreign currency transaction risks?
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What is transaction exposure a measure of?
What is transaction exposure a measure of?
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What is the primary objective of a financial manager in measuring and managing foreign exchange exposure?
What is the primary objective of a financial manager in measuring and managing foreign exchange exposure?
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What causes transaction exposure for existing obligations?
What causes transaction exposure for existing obligations?
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When does transaction exposure arise?
When does transaction exposure arise?
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What type of exposure measures the change in the present value of a firm due to changes in future operating cash flows?
What type of exposure measures the change in the present value of a firm due to changes in future operating cash flows?
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What is the impact of exchange rate changes on transaction exposure?
What is the impact of exchange rate changes on transaction exposure?
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How does a stronger currency affect the export market?
How does a stronger currency affect the export market?
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What is the nature of transaction exposure?
What is the nature of transaction exposure?
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What is the primary defense against economic risk?
What is the primary defense against economic risk?
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What is the time period associated with transaction exposure?
What is the time period associated with transaction exposure?
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What is the impact of an exchange rate change on a firm's value?
What is the impact of an exchange rate change on a firm's value?
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What is the relationship between transaction exposure and cash flows?
What is the relationship between transaction exposure and cash flows?
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What is the term for the risk that arises from long-term exchange rate fluctuations affecting the competitiveness of exports and imports?
What is the term for the risk that arises from long-term exchange rate fluctuations affecting the competitiveness of exports and imports?
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What is the impact of transaction exposure on a company's financial situation?
What is the impact of transaction exposure on a company's financial situation?
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What happens to imports when a currency gets stronger?
What happens to imports when a currency gets stronger?
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How does a stronger currency affect home businesses that neither import nor export?
How does a stronger currency affect home businesses that neither import nor export?
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Study Notes
Foreign Exchange Exposure
- Foreign exchange exposure is a measure of the potential change in a firm's profitability, net cash flow, and market value due to a change in exchange rates.
- It can be classified into three types: transaction, operating, and translation exposure.
Translation Exposure
- Also known as accounting exposure, it is the potential for accounting-derived changes in owner's equity due to the need to translate foreign currency financial statements into a single reporting currency.
- This risk arises from the difference in exchange rates for acquiring assets, liabilities, and equities and those for generating consolidated financial statements.
- The value of foreign operations rises and falls as exchange rates alter, but there is no cash flow effect.
- The effect can be reduced by using loans in the foreign currency to part-finance the subsidiary.
Transaction Exposure
- Measures changes in the value of existing foreign-currency-denominated obligations, which were incurred prior to an exchange rate change but are not due to be settled until after the exchange rate change.
- Changes in exchange rates cause transaction exposure for existing obligations, which start in the past and end in the future.
- This type of exposure can be defined as changes in cash flows of current existing contractual obligations due to the movement of exchange rates.
Transaction Exposure Reduction Techniques
- Invoicing in domestic currency to pass the foreign currency risk onto the customer/supplier.
- Leading and lagging: accelerate or delay the currency exchange to get a better rate.
- Matching assets and liabilities.
- Forward contracts.
- Interest rate hedging.
- Futures.
- Options.
Operating Exposure
- Also known as economic exposure, competitive exposure, or strategic exposure, it measures the change in the present value of the firm resulting from an unexpected change in exchange rates.
- The change in a firm's value depends on the impact of the exchange rate change on future sales volume, product prices, and costs in the following years.
- It is a longer-term exchange rate fluctuation that affects the competitiveness of exports and imports.
Economic Risk
- Long-term exchange rate fluctuations affect the competitiveness of exports and imports.
- A stronger currency makes exports more expensive and imports cheaper, affecting the competitiveness of home businesses.
- The only defense is to diversify the customer and supplier base and hope that not all currencies move in the same direction.
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Description
Learn about the different types of foreign exchange exposure, including translation exposure, and how it affects a company's financial statements.
