 The risk, faced by companies involved in international

trade, that currency exchange rates will change after the

companies have already entered into financial obligations.
 Such exposure to fluctuating exchange rates can lead to
major losses for firms.
 Transaction exposure emerges mainly on account of export
and import of commodities, borrowing and lending in
foreign currency and intra- firm flows in an international
company.
 = rupee worth of accounts receivable (payable) when actual
settlement is made - rupee worth of accounts receivable
(payable) when trade transaction was initiated.
 Suppose an Indian firm exports goods to the US and
the bill is invoiced in USD. It has to receive payment in
2 months but within this period USD depreciates.
 This will cause a reduction in earnings in rupee terms.
If USD appreciates it will make export earning bigger
in rupee terms.
 If an Indian importer imports goods from US and if
the USD appreciates before payment is made in USD,
it will have to pay more in rupees.
 Transaction exposure also emerges when borrowing or
lending is done in foreign currency.
 If foreign currency appreciates, the burden of
borrowing will be more in terms of domestic currency
and vice versa.
 In case of intra firm flow, suppose the Indian
subsidiary of an American firm has declared dividend
and the amount has to be sent to the parent company.
In the meanwhile the rupee depreciates; the amount of
dividend to be received by parent company in dollars
will reduce and cause loss to parent company. Eg.
Mahindra & Mahindra.
 Insuring against transaction risk to reduce or eliminate the
effects of unexpected changes in exchange rates.
 You can hedge only at market rates. The effects of expected
changes in exchange rates are incorporated in these market
rates.
 Hedging is insurance. The purpose of hedging is to reduce
or eliminate risks, not to make profits. FOREX-
Management of exposure risks
 The purpose of hedging is to manage a firms foreign
exchange exposure by minimizing home currency outflows
(payables/liabilities) and maximizing home currency
inflows(receivables/assets). FOREX-Management of
exposure risks.