Question

Explain Transaction Exposure and why this may be a potential foreign exchange risk for an Australian business exporting internationally. Discuss how Leading and Laggingstrategies could be appropriate for managing risk?

Answer 1

SOLUTION

TRANSACTION EXPOSURE

Transaction exposure or translation exposure is the level of uncertainity businesses involved in international trade face. Specifically, it is the risk that currency exchange rates will fluctuate after a firm has already undertaken a financial obligation. A high level of vulnerability to shifting exchange rates can lead to major capital losses for these international businesses. One way that firms can limit their exposure to changes in the exchange rate is to implement a hedging strategy. Through hedging using forward rates, they may lock in favorable rate of currency exchange and avoid exchange to risk.

POTENTIAL FORIEGN EXCHANNGE RISK FOR AN AUSTRALIAN BUSINESS

One of the major risks that an exporter faces is fluctuations in foriegn currency exchange rates. Currency variations can quickly have a significant impact on your bottom line and, in extreme cases even threaten a company's survival. The foriegn exchande market allows businesses to convert one currency into the other. For example, it would allow an expoter selling goods to Germany to payment in Euros and convert this amount into austrian dollars. As an exporter foriegn exchange risk often occurs because generally you will need to convert your invoice into your clients currency at the prevailing rate on the date the invoice is issued. Your client then settles the invoice in the local currency, typically between 30 and 90 days later depending on the terms that have demanded and then only the funds has been recieved, can you convert the payment into AUD.

LEADS AND LAGS

When a business has an expected foriegn exchange transaction as a result of a deal, it may need to buy or sell a certain currency. If the company believes that the currency may move in a certain direction that may speed up the transaction or delay it to take advanntage of a potential outcome. Normal price movement from supply and demand between countries can be very difficult to forecast, but certain potential events may have a known time line and can be easily anticipated. Accelarating a transaction is known as leading, while slowing it down is known as lagging.