NAME - Sannati Haswar.

ROLL NO - 20.
SUBJECT - International Finance.
PTMBA - Trim V.

FOREIGN EXCHANGE EXPOSURE AND RISK MANAGEMENT

When a company undertakes risk through transacting in foreign currencies, it is referred to
as “foreign exchange exposure”. The change in the foreign exchange rates frequently can
have an adverse effect on the financial transactions denominated in some other foreign
currency rather than the domestic one.
Due to the volatility of the foreign exchange rates, the change in its value affects the firm’s
future cash flows in which it has maintained its book of accounts (Balance Sheet)
Firms both directly or indirectly related to international business face risk of foreign
exposure who make financial transactions in foreign currency denominations. It can be
defined as the risk of loss stemming from exposure to adverse foreign exchange rate
movements.
It is used to describe the degree at which the potential/ future profitability , net cash flow
and perceived market value of a firms value changes as a result of change in exchange rate,
i.e to say that it is a company’s profitability of making either a profit or loss as a result of
movements in exchange rates.
It relates to the effect of unexpected exchange rates changes on the value of the firm. In
particular, it is defined as the possible direct or indirect loss in the firm’s cash flows, asset
and liability, net profit and in turn, its stock market value from an exchange rate move.
Like two sides of a coin, here also one side states that foreign exchange rate exposure is
irrelevant. It argues based on Purchasing Power Parity (PPP) Theory which explains that the
movement in exchange rate is matched by the movement in price (inflation rate) and so, the
financial performance of a firm is not affected.
The other side mentions that exchange rate exposure is very relevant because PPP theory is
not applicable in short run. Even in the long run, there so many factors other than inflation
rate differential , that influence exchange rate. If the exchange rate changes due to some
other factors, the resulting exposure will not be matched by the inflation rate differential,
and the fee could really matter.
TYPES OF FOREIGN EXCHANGE EXPOSURE:
1. TRANSACTION EXPOSURE:
It means changes in present cash flow of a firm consequent upon the exchange rate
changes. It is basically the cash flow risk and deals with the effect of exchange rate moves
on transactional account exposure related to receivables (export contracts),payables
(import contracts), or repatriation of dividends. It is also Rupee worth of accounts receivable
(payable) when actual settlement is made minus Rupee worth of accounts receivable
(payable) when the trade transaction was initiated.
It emerges mainly on account of:
 Import and export of commodities on open account
 Lending and borrowing in foreign currencies.
 Intra-firm flow in MNC’s.
It is further classified in three types:
I. Quotation Exposure :- It is created when the exporter quotes a price in foreign
currency and exists till the importer places an order at that price.
II. Backlog exposure :- this exists between the placement of order by the importer and
the shipping and billing by the seller.
III. Billing Exposure :- it exists between the billing of the shipment and the settlement of
the trade payments.
Example :-
 Indian exporter exports goods to USA, bill invoices in US $, has to receive the
payment in two months, US $ depreciates vis-à-vis Indian rupee, this will cause
reduction in earnings in terms of INDIAN RUPEE. The opposite will be the case if US
$ appreciates vis-à-vis INDIAN RUPEE and Indian exporters earnings will be more in
terms of Indian rupee.
 Indian importer imports goods from USA, bill invoices in US $, has to pay in two
months, within the period US $ depreciates vis-à-vis Indian rupee, less Indian rupee
will be paid to meet the obligation. The opposite will be the case if US $ appreciates
vis-à-vis INDIAN RUPEE and the Indian importer will have to pay more in terms of
Indian rupee to make the payment.
 For both the Indian importer and exporter, there will be no transaction exposure if
the bill is invoiced in Indian rupee.
 Indian subsidiary of an USA form declared dividend, it has to be repatriated to the
parent company , in the mean time rupee depreciates, amount of dividend received
by US parent company will be less in terms of US dollar, this will amount to a loss to
the parent company. The opposite will happen if rupee appreciates vis-à-vis US
dollar.
 USA subsidiary of an Indian firm declared dividend, it has to be repatriated to the
parent company, in the mean time US dollar depreciates vis-à-vis Indian rupee,
amount of dividend received by Indian parent company in terms of Indian rupee will
be less, this will amount to a loss to the parent company. The opposite will happen if
US dollar appreciates vis-à-vis Indian rupee. The parent company will get more in
terms of INR as dividend.
Consolidated net exposure means the changes in net cash flow from all the sources. The
word “net” compromises both the inflow and outflow of funds and it is the net amount that
determines the size of transaction exposure. It covers all the imports and exports,
borrowing and lending , intra-firm flow located with different counties.
2. REAL OPERATING EXPOSURE :
It arises when changes in exchange rate, together with the rate of inflation , alter the
amount and risk element of a company’s future revenue and cost stream, i.e future cash
flow.
It is based on the extent to which the value of the firm – as measured by the present value
of its expected cash flows- will change when exchange rate changes. It manifests in changes
in inflation adjusted future cash flow of a firm following exchange rate changes.

For example, if Indian company is competing against the products imported from China and
if the Chinese yuan per Indian rupee falls, then the importers enjoy decreased cost
advantage over the Indian company. This shows, that the companies not having any direct
link to the forex do get affected by the change in the foreign currency.

References
https://www.investopedia.com/terms/f/foreignexchangerisk.asp
https://www.slideshare.net/taher666/foreign-exchange-exposure-41882267