Foreign Exchange Exposure

and Risk.

World is changing faster than human

Endeavor
Currency Exposure
 Short Term
a. Accounting ( Translation)
b. Cash Flow
I. Contractual( Transactions)
II. Anticipated
 Long Term
a. Operating
b. Strategic

Referred International Financial Manageme 2

nt by P.G. Apte, fifth edition
Exposure and Risk
 Though exposure and risk are used interchangeably
 But Exposure is the measure of the sensitivity of
the value of the financial item( asset liabilities or
cash flow) to change in relevant risk factor
 while Risk is a measure of variability of the value of
the item attributable to the risk factor.
 Example: Firm export import having significant
exposure to Foreign exchange rate. But may not
perceive significant risk as the dollar –rupee
exchange rate is stable for last so many months

Referred International Financial Manageme 3

nt by P.G. Apte, fifth edition
( Accounting) Translation Exposure

 Translation Exposure is also known as the

Accounting Exposure
 A firm may have assets and liabilities denominated
in foreign currency.
 Accounting standard which governs the reporting
and disclosure practices, the firm must translate the
values of these currency –denominated items into
home currency and report these in the balance
sheet.

Referred International Financial Manageme 4

nt by P.G. Apte, fifth edition
Translation Exposure
 Translation exposure typically arise when a parent
multinational company required to consolidate a
foreign subsidiary's financial statement
 Example At the beginning of the financial year the
subsidiary has real estate, inventories and cash
valued at $100000, $200000, and $150000
respectively the spot rate is 1$= 46 Rs, by the close
of financial year the values are changed as dollar
depreciated to Rs at 1$ = 42Rs here the Indian
concern with USA subsidiaries will make huge loss
of $450000*(Rs 46 – Rs 42).

Referred International Financial Manageme 5

nt by P.G. Apte, fifth edition
Translation Loss or gain

 The loss suffered by converting the assets

and liabilities from foreign currency to
domestic currency is known as transaction
loss.
 Similarly for the gain.

Referred International Financial Manageme 6

nt by P.G. Apte, fifth edition
( Contractual) Transactions Exposures

 It measures the sensitivity arises when the assets or

liabilities are liquidated due to change in the
exchange rate.
 Examples: A currency has to be converted in order
to make or receive payment for goods and services-
import payable or export receivables denominated in
a foreign currency
 A currency has to be converted to make a dividend
payment, royalty, payment and receivable to repay
foreign loan and interest.

Referred International Financial Manageme 7

nt by P.G. Apte, fifth edition
Transaction Risk
 An unanticipated change in the exchange rate has
an impact favorable or adverse on its cash flows.
 Transaction risk can be defined as a measure of
variability of assets and liabilities when they are
liquidated. May lead to exchange gain or loss.
The key difference between transaction exposure and
translation is that former has impact on cash flows
while latter has no direct effect on cash flows. ( This
is true if there is no tax effects arising out of
translational gains or loss. )

Referred International Financial Manageme 8

nt by P.G. Apte, fifth edition
Anticipated

 Sometimes transaction is being negotiated,

all terms more and less finalized but a
contractual agreement yet to be entered into.

Referred International Financial Manageme 9

nt by P.G. Apte, fifth edition
Strategic exposure
 The focus impact of cash flows of firm in years to
come
 Horizon are long nothing is contractually fixed and
the impact of exchange rate fluctuations can have
substantial, sustained implication
 In long run exchange rate effect can undermine a
firm's competitive advantage by raising by raising it’s
cost above the competitors cost.

Referred International Financial Manageme 10

nt by P.G. Apte, fifth edition
 Unanticipated exchange rate change on
firm’s revenue, operating cost and operating
net cash flow over a medium term horizon
 Change in exchange rate can affect on
sales volume, input cost of imported
materials, labour costs, interest costs,
inflation, income distribution

Referred International Financial Manageme 11

nt by P.G. Apte, fifth edition
Operating Exchange Exposure

 Of two kind of long term exposure operating

and strategic .
 Operating exposures capture the impact of
unanticipated exchange rate changes on the
firm’s revenue, operating costs and operating
net cash flows over a medium term say up to
three years.

Referred International Financial Manageme 12

nt by P.G. Apte, fifth edition
 Thank You

 Exposure can be Covered , Risk can be

Neutralized completely it needs self
confidence, patience and courage to be
Creative. Not stress , tension and frustration
to feel desperate..

Referred International Financial Manageme 13

nt by P.G. Apte, fifth edition