Meaning:
— FE Exposure can be defined as the risk of loss stemming
PREPARED BY:
MD TAHER AHMED
M.COM 2013-15
ASSAM UNIVERSITY, SILCHAR
RELEVANCE OF EXPOSURE:
1. There is one view that any talk of Exchange Rate
Exposure is irrelevant. The argument is based on the
PPP theory which explains that the movement in ER
is matched by the movement in price (inflation rate)
and so, the financial performance of a firm is not
affected.
2. The other view suggests that the ER Exposure is very
relevant because PPP theory is not applicable in
short run. Even in the long run, there are so many
factors other than Inflation Rate Differential, that
influence ER. If the ER changes due to some other
factors, the resulting exposure will not be matched
by the Inflation Rate Differential, and the FEE could
really matter.
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from exposure to adverse foreign exchange rate
movements.
— FE exposure is used to describe the degree at which the
potential/future profitability, net cash flow and perceived
market value of a firm’s value changes as a result of change
in exchange rate, i.e. to say that it is a company’s
probability of making either a loss or profit as a result of
movements in ER.
— FE Exposure relates to the effect of unexpected ER changes
on the value of the firm. In particular, it is defined as the
possible direct loss or indirect loss in the firm’s cash flows,
assets & liabilities, net profit & in turn, its stock market
value from an exchange rate move.
2
MNCs’ view on FE Exposure:
1) Starbucks: “In fiscal 2004, international company
revenue [in US $] increased 32%,[in part] because of
the weakening US $ against both Canadian $ and the
British pound.” (2005)
2) Nike: “Our international operation and sources of
supply are subject to the usual risk of doing business
abroad, such as possible revaluation of currencies.”
(2005)
3) McDonalds: “In 2000, the weak Euro, British Pound
and Australian Dollar had a negative impact upon
reposted [US $] results.” (2000)
 TYPES OF EXPOSURE: TRANSACTION EXPOSURE:
FOREIGN EXCHANGE EXPOSURES Transaction Exposure means changes in the present
cash flow of a firm consequent upon the exchange rate
changes.
TE is basically the cash flow risk and deals with the
TRANSLATION/ACCOUNTING
ECONOMIC EXPOSURE EXPOSURE effect of exchange rate moves on Transactional account
(involving change in cash flow) IN FE RATE à IN
ACCOUNTING STATEMENT ONLY
exposure related to receivables (export contracts),
payables (import contracts), or repatriation of
dividends.
REAL OPERATING EXPOSURE
TRANSACTION EXPOSURE (involving change in future cash flow)
Transaction Exposure= Rupee worth of accounts
(involving change in present cash flow) IN FE RATE à IN FUTURE CASH
FLOW
receivable (payable) when actual settlement is made
IN FE RATE à IN
OUTSTANDING OBLIGATION minus Rupee worth of accounts receivable (payable)
when the trade transaction was initiated.

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Contd.
IMPACT OF TRANSACTION EXPOSURE:
Transaction Exposure emerges mainly on account of:
— Export & Import of commodities on open account.
— Borrowing & Lending in Foreign Currencies.
— Intra-firm flow in MNCs.
Transaction Exposure is of three types:
Ø Quotation Exposure– it is created when the exporter quotes a
price in FC & exists till the importer places an order at that
price.
Ø Backlog Exposure– this exists between the placement of order
by the importer & the shipping and billing by the seller.
Ø Billing Exposure– it exists between the billing of the shipment
& the settlement of the trade payments.
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q ON EXPORT-IMPORT:
ü Indian exporter exports goods to USA à bill invoices in US $
à has to receive the payment in 2 months àUS $ depreciates
vis-à-vis INR à this will cause a reduction in his earnings in
terms of INR. The opposite will be the case if US $ appreciates
vis-à-vis INR & Indian exporter’s earnings will be more in
terms of INR.
ü Indian importer imports goods from USA à bill invoices in
US $ à has to pay in 2 months à within the period US $
depreciates vis-à-vis INRà less INR will be paid to meet the
obligation. The opposite will be the case if US $ appreciates
vis-à-vis INR & the Indian importer will have to pay more in
terms of INR to make the payment.
ü For both the Indian Exporter & Importer, there will be no TE
if the bill is invoiced in INR.
 qON BORROWING & LENDING:
Ø Indian borrower borrowed from USAà has to pay in US
$ à if US $ depreciates vis-à-vis INR à he has to pay
less in terms of INR, i.e. his debt burden will be lesser.
The opposite will be the case if US $ appreciates vis-à-vis
INR. He will have to pay more in terms of INR to meet
the debt obligation.
Ø Indian lend money to USA à has to receive in US $ à
if US $ appreciates vis-à-vis INRà he will receive more
in terms of INR. The opposite will be the case if US $
depreciates vis-à-vis INR. The Indian Lender will earn
less in terms of INR.
Ø There will be no Transaction Exposure if borrowing &
lending is done in local currency.
qON INTRA-FIRM FLOW:
ü Indian subsidiary of an USA firm declared dividend à
it has to be repatriated to the parent Co. à in the
mean time rupee depreciates à amount of dividend
received by US parent Co. will be less in terms of $ à
this will amount to a loss to the parent company. The
opposite will happen if Rupee appreciates vis-à-vis US
$.
ü USA subsidiary of an Indian Firm declared dividendà
it has to be repatriated to the parent Co. à in the
mean time US $ depreciates vis-à-vis INR à amount
of dividend received by Indian parent company in
terms of INR will be lessà this will amount to a loss to
the parent company. The opposite will happen if US $
appreciates vis-à-vis INR. The parent will get more in
terms of INR as dividend.

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CONSOLIDATED NET EXPOSURE: Contd:

ü Consolidated Net Exposure means the changes in net — Solution :
cash flow from all the sources. The word ‘net’
comprises both the inflow and outflow of funds and it
Net Inflow Pre-change value Post-Change value Size of Exposure
is the net amount that determines the size of TE. It (Rs. in Million) (Rs. in Million) (Rs. in Million)
covers all the imports & exports, borrowing & lending, AUS $ (-) 300 Rs. 50×(-)300= Rs. 55×(-)300= (-) 1500
intra-firm flow located with different counties. (-)15000 (-)16500
¥ (-) 50 Rs. 0.60×(-) 50= Rs. 0.70×(-)50= (-) 5
vCalculate the Consolidated Net Exposure: (-)30 (-)35
AUS $ JAPANESE ¥ BRITISH £ £ (+) 150 Rs. 80×150=12000 Rs. 75×150=11250 (-)750
IMPORT 1550 1200 1050
NET TRANSACTION EXPOSUREà Rs. 2255 Million
EXPORT 1250 1150 1200

PRE-CHANGE RATE Rs. 50/ AUS $ Rs. 0.60/¥ Rs. 80/£

POST-CHANGE RATE Rs. 55/ AUS $ Rs. 0.70/¥ Rs. 75/£

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 mpexx LLtd
Bharatt IIm
Impex
mp d. h
ttd ass tthe
has ow g C
he ffollowing
he ollo
owing Cash
ash lowss ffrom
h FFlows rrom Solution
on: d Net
Consolidated ree:
et Exposure
(Figures
(F
Fiigureees in Thousands)
xport & IImportt business
EExport ss. Findd thee Consolidated d Net Cash Flow GBP CNY EUR SGD USD
Exposurere: £ ¥ € S$ $
IMPORT 1000 750 1200 1100 3500
(Figures in Thousands) EXPORT 900 800 1500 950 3300
PRE-CHANGE RATE ₹100.5 / £ ₹12 / ¥ ₹87.5 / € ₹60.3 / S$ ₹80.4 / $
Cash Flow GBP CNY EUR SGD USD
£ ¥ € S$ $ POST-CHANGE RATE ₹105.3 / £ ₹11.5 / ¥ ₹90.5 / € ₹62.1 / S$ ₹82.3 / $

IMPORT 1000 750 1200 1100 3500 Net Inflow £ (-) 100 ¥ (+) 50 € (+) 300 S$ (-) 150 $ (-) 200
EXPORT 900 800 1500 950 3300 Pre-Change Value (1) ₹100.5 x (-100) ₹12 x (+50) = ₹87.5 x (+300) = ₹60.3 x (-150) = ₹80.4 x (-200)
= - ₹10050 +₹600 +₹26250 -₹9045 = -₹16080
PRE-CHANGE RATE ₹100.5 / £ ₹12 / ¥ ₹87.5 / € ₹60.3 / S$ ₹80.4 / $ Post-Change Value (2) ₹105.3 x (-100) ₹11.5 x (+50) = ₹90.5 x (+300) = ₹62.1 x (-150) = ₹82.3 x (-200)
= - ₹10530 +₹575 +₹27150 -₹9315 = -₹16460

POST-CHANGE RATE ₹105.3 / £ ₹11.5 / ¥ ₹90.5 / € ₹62.1 / S$ ₹82.3 / $ Size of Exposure (2)-(1) - ₹480 - ₹25 + ₹900 - ₹270 - ₹380
Consolidated Net Exposure: - ₹2,55,000

Transaction Exposure Numerical Transaction Exposure Numerical SOLUTION

vAdani Exports is exporting 100 articles for $50 each

and importing 100 units of material at €10 each.
vThey incur other variable expenses of Rs 20,000.
vAt the time of entering contract ₹/$ was 67, at the
time of export ₹65, while ₹/€ at the time of order was
₹72 and at the time of import ₹76/€.
Calculate Transaction exposure.
REAL OPERATING EXPOSURE (ROE):
— Real Operating Exposure 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.
— The Real Operating Exposure 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
IMPACT OF ROE:
— The impact of inflation and changes in ER on the future
cash flow may vary under different market conditions.
— As far as revenue is concerned, the impact may vary if the firm
produces for :--
— The Export Market.
— The domestic market but competition from import is absent.
— The domestic market but competition from import is present.
q In case of cost structure, the impact will be different, if the firm:--

exchange rate changes. q Imports inputs.

q Procure inputs domestically but competition from foreign
supplier is present.
— It manifests in changes in inflation-adjusted future cash q Get inputs domestically & there is no competition from abroad.
flow of a firm following ER changes.

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ROE, MEASURING THE IMPACT ON CASH FLOW:

For a precise estimation of the ROE, one has to take the
following into the consideration:-
— Expected inflation rate differential.
— Expected change in exchange rate.
— Price elasticity of demand for the product.
— The differentiated feature of the product.
— Ratio of imported input in the total input.
— Possibility of acquiring the inputs domestically.
Ø Estimate the cash flow- revenue and cost stream considering
all these combination and possibilities.
Ø Find out the present value of estimated cash flow and this is LAKER AIRWAYS VIDEO
compared with present value of the expected cash flow that is
to occur in terms of real exchange rate. The difference is ROE. LAKER AIRWAYS CASE
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Translation Exposure: METHODS OF TRANSLATION:
— Translation/Accounting Exposure is the mismatch between There are four methods of translation:-
the translated value of assets and liabilities following the
ER change. It emerges on account of consolidation of
ÅCurrent Method
financial statements of different subsidiaries of a parent ÅCurrent/ Non-current Method.
MNC. When the ER changes, value of the consolidated ÅMonetary/ Non-monetary Method.
financial statement also changes. The extent of this change
ÅTemporal Method
represents the magnitude of Translation Exposure (TsE).

— Size of the TsE depends on:-

— The extent of change in the related currencies.
— Extent of involvement of subsidiaries in parent’s business.
— Location of subsidiaries in countries with stable/unstable
currencies.
— Methods of translation.

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SUMMARY OF TRANSLATION METHODS:

FOREIGN CURRENT CURRENT/ MONETARY/ TEMPORAL FOREIGN CURRENT CURRENT/ MONETARY/ TEMPORAL
EXCHANGE RATE NON- NON- METHOD EXCHANGE RATE NON- NON- METHOD
RATE METHOD CURRENT MONETARY RATE METHOD CURRENT MONETARY
METHOD METHOD METHOD METHOD

CURRENT All items Current assets All liabilities & All liabilities &
RATE & current Current Assets Current Assets
liabilities except if inventory is
inventory shown at MP

HISTORICAL Fixed assets & Inventory & Fixed Assets &

RATE long term Fixed Assets Inventory is
liabilities not shown at
MP

AVERAGE Income Income Income

RATE statement statement statement
items except items except items except
those related those related those related
to fixed assets to fixed assets to fixed assets
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FOREIGN CURRENT CURRENT/ MONETARY/ TEMPORAL FOREIGN CURRENT CURRENT/ MONETARY/ TEMPORAL
EXCHANGE RATE NON- NON- METHOD EXCHANGE RATE NON- NON- METHOD
RATE METHOD CURRENT MONETARY RATE METHOD CURRENT MONETARY
METHOD METHOD METHOD METHOD

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MANAGEMENT OF EXPOSURES:
FOREIGN CURRENT CURRENT/ MONETARY/ TEMPORAL
EXCHANGE RATE NON- NON- METHOD HEDGING TECHNIQUES
RATE METHOD CURRENT MONETARY
METHOD METHOD

NATURAL HEDGES
CONTRACTUAL HEDGES
1. LEADS AND LAGS
1. FORWARD MARKET HEDGE
2. CROSS HEDGING
2. HEDGING THROUGH
3. CURRENCY
CURRENCY FUTURES
DIVERSIFICATION
3. HEDGING THROUGH
4. RISK-SHARING
CURRENCY OPTIONS
5. PRICING OF TRANSACTION
4. MONEY MARKET HEDGE
6. PARALLEL LOANS
7. CURRENCY SWAPS
8. MATCHING OF CASH
FLOWS

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CONCLUSION:
In today's Globalised world, every business firm
irrespective of foreign trade feels the heat of Foreign
Exchange Exposure & it needs to be managed to
carefully in order to keep the company’s value, future
cash flow and Competitive position intact. FEE affects
the MNCs directly while the effect on others is
Indirect. Hence managing FEE is a must for
maximizing the firm’s value and minimizing the risk.

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