Exposure- Foreign

Exchange
 Exposure & Risk
 Exposure is a measure of sensitivity of the
firm’s performance, however measured, to
fluctuations in the relevant risk factor.
 Risk is a measure of the extent of variability
of the performance measure attributable to
the risk factor.

 A high degree of risk factor is necessary but not

sufficient to give rise to a high degree of perceived
risk.
 If the underlying risk factor- exchange rate, interest
rate or commodity price is expected to remain fairly
stable over the planning horizon, the firm may not
perceive a high degree of risk associated with that
risk factor.
Taxonomy of Currency
Exposure
 Short term
 Translation

 Transaction
 Long term

 Operating
Translation Exposure

 Translation/Accounting:
 Changes in the book value of assets and liabilities and income
statement items that are caused by an exchange rate change.
 The resulting exchanges gains/losses as per the accounting
rules.
 Retrospective
Transaction Exposure

 Transaction:
 Changes in the value of o/s foreign currency denominated
contracts that are brought about by an exchange rate change.
 Gains & Losses are determined by the nature of the contracts
already entered into.
 Retrospective and prospective:
 Activities occurred in the past, but will be settled in
the future.
Operating Exposure

 Operating:
 Changes in the amount of future operating cash flows caused
by an exchange rate change.
 Gains/Losses are determined by the changes in the future
competitive position.
 Prospective, as it is based on the future activities.