Question

Firm XYZ:

1. Your firm sells goods domestically and abroad.

2. The firm has a payment due in 3 months time worth 400,000 EUR to foreign supplier.

3. A U.S. importer owes the firm 300,000 USD, due in 4 months.

Economic environment:

1. RBA is considering implementing an expansionary monetary policy by lowering the cash rate.

2. Economic growth of your foreign markets, where you export your goods, has declined relative to domestic economic growth.

3. The firm is considering issuing 500,000 USD bonds with a maturity of 1 year.

QUESTION: 1. Use the information above to consider the types of exposure your firm may face.

Answer 1

There is foreign exchange exposure that firm may face. It exists when value of future cash flows depends on the value of foreign currencies. Following are three types of foreign exchange exposure.

Transaction exposure

This exposure exists when actual transaction takes place which involves foreign currency. It is risk faced by firm due to change in exchange rates before contract is settled. It is exposure in change in foreign exchange rates between dates when transaction is accounted and when it is settled. Import and export of goods is example of transaction exposure.

Translation exposure

It arises when holding company and subsidiary companies are situated in different countries. So there is risk that company’s equities, assets, liabilities will change due to change in exchange rates. This exposure is the result of translation of books of accounts into home currency.

Economic exposure

It directly impacts value of firm. It can affect assets as well as operating cash flows of firm. It is long term in nature. Change in the economy in any one of the companies in which firm is operating will have impact on firm’s investments and operations.

Firm has following transactions

1. Firm sells goods domestically and abroad

2. Firm has payment due in 3 months of 400,000 EUR to foreign supplier

3. US importer owes firm 300,000 USD, due in 4 months

Considering above transactions firm is facing transaction exposure as these involve foreign currency and there is risk of change in exchange rates.

Firm is operating in following economic environment   

1. RBA considering lowering cash rate

2. Economic growth of foreign markets declining

3. Issue 500,000 USD bonds with maturity of 1 year

Considering above economic environment firm is facing economic exposure as it will impact on overall financial stability of firm.

Therefore firm XYZ may face transaction and economic exposures. As per the given information, firm may not face translation exposure as it doesn’t have any subsidiaries operating in different currency.