Question

2.There are as many different approaches to foreign exchange transaction exposure management as there are firms and no real consensus exists regarding the best approach. List and discuss three different exposures you can hedge and three different types of hedges.

Answer 1

Three types of foreign exchange exposure one can hedge are-

1. Transaction exposure- Any transaction that relates to buying and selling of foreign currency leads to transaction exposure.

2. Translation exposure- This exposure is of accounting nature and it relates to gain or loss made from conversation or translation of subsidiary books of accounts.

3. Economic exposure- Economic exposure is long term impact of transaction exposure. If a company is affected by unavoidable exposure to foreign currency for a long term, it is said to have an economic exposure.

Three different types of hedges related to foreign exchange exposure are-

1. Cash flow hedge- This types of hedges mitigates the risk from changes in value of cash flows. These are mostly derivatives like future, forward etc.

2. Fair value hedge- This type of hedge reduce the adverse situations in Market value of an asset. Thus types of hedging works in opposite direction.

3. Net Investment Hedge- This type of hedging is used in management of net Investment exposure from a foreign currency.